The LP formula is based upon the substitution of the exogenous risk aversion hypothesis by a credit equilibrium hypothesis. This leads to a trade-off between expected blue-sky return – the expected return excluding default scenarios – and extreme risk estimated from scenarios leading to...

This paper analyzes the Risk Appetite Index (RAI), a measure of investors� risk aversion proposed by Kumar and Persaud (2001, 2002). We show that the RAI distinguishes between risk and risk aversion only under theoretically restrictive assumptions on the distribution of returns and the...