Does the More Risk-averse Investor hold a Less Risky Portfolio?∗

We study the suitability of using absolute risk aversion as a measure of willingness to take risk in the Arrow-Debreu portfolio framework. A global measure of risk for Arrow-Debreu portfolios is introduced. This measure is termed ‘conservatism’. We show that the concept of ‘more conservative’ is stronger than that of ‘more risk-averse’. A higher absolute risk aversion is only necessary but not sufficient to induce a less risky Arrow-Debreu portfolio. Our results challenge the well-accepted notion that a more riskaverse investor holds a less risky portfolio. ∗The major part of the work in this paper was done when Wong was pursuing his Ph.D. study. Wong is greatly indebted to the numerous contributions made by his supervisors: Christine Brown, Paul Kofman and Richard Stapleton. Special thanks is due to Bruce Grundy for his constructive advises which significantly improve the paper. We also thank Qi Zeng and seminar participants at the University of Melbourne for their helpful comments. †Corresponding author. Department of Accounting and Finance, Faculty of Business and Economics, Monash University. Email: [email protected]. Tel: 61-3-99052322.Fax: 61-3-9905-5475.