Portfolio choice and equilibrium in capital markets with safety-first investors

Arzac, Enrique R.; Bawa, Vijay S.

doi:10.1016/0304-405x(77)90003-4

Cited by 179 publications

(106 citation statements)

References 14 publications

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“…Let W i,j be the random final value of asset j and let µ be the expected return to the portfolio, i.e., µ =E(R). Arzac and Bawa (1977) study the implications of the following lexicographic form of the safety first principle:…”

Section: Iia Safety Firstmentioning

confidence: 99%

“…Arzac and Bawa (1977) show that a risk averse safety first investor can solve the optimization problem in two stages. First, the investor maximizes the ratio ofthe risk premium to return opportunity loss that she can incur with probability δ,…”

Section: Iia Safety Firstmentioning

confidence: 99%

“…Roy (1952) and Arzac and Bawa (1977) proposed using the Tchebychev inequality to approximate the tail of the risky 6 portfolio distribution from above. That is,…”

Section: Iia Safety Firstmentioning

confidence: 99%

“…Roy (1952) introduced the safety first criterion, which was further developed by Arzac and Bawa (1977). Under the safety first criterion, an investor minimizes the chance of a very large negative return, a return that, if realized, would reduce the investor's portfolio value below some threshold level.A safety first investor might be worried about a one-time large event that might drive her or her firm out of business.The safety first rule might be more appropiate for investors investing in emerging markets than in well established markets because emerging market equity distributions 3 are greatly influenced by extreme returns.…”

Section: -Introductionmentioning

confidence: 99%

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Extreme observations and diversification in Latin American emerging equity markets

Susmel

2001

Journal of International Money and Finance

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In this paper, we focus on the tails of the unconditional distribution of latin American emerging markets stock returns. We explore their implications for portfolio diversification according to the safety first principle, first proposed by Roy (1952). We find that the Latin American emerging markets have significantly fatter tails than industrial markets, especially, the lower tail of the distribution. We consider the implication of the safety first principle for a U.S. investor who creates a diversified portfolio using Latin America stock markets. We find that a U.S. investor gains by adding Latin American equity markets to her purely domestic portfolio. For different parameter specifications, we find a more realistic asset allocation than the one suggested by the literature based on the traditional meanvariance framework.JEL: C53, G15 * I thank Rich Pettit and Ramon Rabinovitch for his useful comments.

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Section: Iia Safety Firstmentioning

confidence: 99%

Section: Iia Safety Firstmentioning

confidence: 99%

“…Roy (1952) and Arzac and Bawa (1977) proposed using the Tchebychev inequality to approximate the tail of the risky 6 portfolio distribution from above. That is,…”

Section: Iia Safety Firstmentioning

confidence: 99%

Section: -Introductionmentioning

confidence: 99%

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Extreme observations and diversification in Latin American emerging equity markets

Susmel

2001

Journal of International Money and Finance

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“…Roy's criterion delimits the probability of highly adverse outcomes and maximizes expected return, while Markowitz' solution trades off the mean return against the variance as a risk indicator. Though less popular than the mean variance tradeoff, the concern for the downside risk aspect remained, as evidenced by Markowitz's (1959) contribution using the semi-variance, Arzac and Bawa's (1977) extension of Roy's safety first criterion and Leland's (1980) portfolio insurance. The downside risk measures received renewed attention with the official adoption of the Value-at-Risk (VaR) measure in the Basel capital accords and the attention for downside risk concerns in behavioral finance.…”

Section: Introductionmentioning

confidence: 99%

Optimal portfolio allocation under the probabilistic VaR constraint and incentives for financial innovation

et al. 2007

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We characterize the investor's optimal portfolio allocation subject to a budget constraint and a probabilistic VaR constraint in complete markets environments with a finite number of states. The set of feasible portfolios might no longer be connected or convex, while the number of local optima increases exponentially with the number of states, implying computational complexity. The optimal constrained portfolio allocation may therefore not be monotonic in the state-price density. We propose a type of financial innovation, which splits states of nature, that is shown to weakly enhance welfare, restore monotonicity of the optimal portfolio allocation in the state-price density, and reduce computational complexity.We are grateful to Ken Kavajecz and seminar participants at Harvard Business School, London School of Economics, Maastrict University, ZEI Bonn, and Danske Bank Symposium on Asset Allocation and Value-at-Risk: Where Theory Meets Practice for comments on an earlier version of this paper. We also benefitted from the suggestions of two anonymous referees. Our papers can be downloaded from www.RiskResearch.org.

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Individual Investor Portfolios

Polkovnichenko¹

2010

Behavioral Finance

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Portfolio choice and equilibrium in capital markets with safety-first investors

Cited by 179 publications

References 14 publications

Extreme observations and diversification in Latin American emerging equity markets

Extreme observations and diversification in Latin American emerging equity markets

Optimal portfolio allocation under the probabilistic VaR constraint and incentives for financial innovation

Individual Investor Portfolios

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