This paper develops optimal portfolio choice and market equilibrium when investors behave according to a generalized lexicographic safety-first rule. We show that the mutual fund separation property holds for the optimal portfolio choice of a risk-averse safety-first investor. We also derive an explicit valuation formula for the equilibrium value of assets. The valuation formula reduces to the well-known two-parameter capital asset pricing model (CAPM) when investors approximate the tail of the portfolio distribution using Tchebychev's inequality or when the assets have normal or stable Paretian distributions. This shows the robustness of the CAPM to safety-first investors under traditional distributional assumptions. In addition, we indicate how additional information about the portfolio distribution can be incorporated to the safety-first valuation formula to obtain alternative empirically testable models.
Arzac, Enrique, and Vijay Bawa. "Portfolio Choice and Equilibrium in Capital Markets with Safety-First Investors." Journal of Financial Economics 4 (May 1977): 277-88.
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