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An analysis of portfolio selection with background risk

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  • Jiang, Chonghui
  • Ma, Yongkai
  • An, Yunbi
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    Abstract

    This paper investigates the impact of background risk on an investor's portfolio choice in a mean-variance framework, and analyzes the properties of efficient portfolios as well as the investor's hedging behaviour in the presence of background risk. Our model implies that the efficient portfolio with background risk can be separated into two independent components: the traditional mean-variance efficient portfolio, and a self-financing component constructed to hedge against background risk. Our analysis also shows that the presence of background risk shifts the efficient frontier of financial assets to the right with no changes in its shape. Moreover, both the composition of the hedge portfolio and the location of the efficient frontier are greatly affected by a number of background risk factors, including the proportion of background assets in total wealth and the correlation between background risk and financial risk.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 34 (2010)
    Issue (Month): 12 (December)
    Pages: 3055-3060

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    Handle: RePEc:eee:jbfina:v:34:y:2010:i:12:p:3055-3060

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Background risk Portfolio selection Mean-variance analysis;

    References

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    Cited by:
    1. Huang, Hung-Hsi & Wang, Ching-Ping, 2013. "Portfolio selection and portfolio frontier with background risk," The North American Journal of Economics and Finance, Elsevier, vol. 26(C), pages 177-196.
    2. Taylor, Dominic & Coleman, Les, 2011. "Price determinants of Aboriginal art, and its role as an alternative asset class," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1519-1529, June.
    3. Alghalith, Moawia, 2012. "The impact of background risk," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 391(24), pages 6506-6508.
    4. Baptista, Alexandre M., 2012. "Portfolio selection with mental accounts and background risk," Journal of Banking & Finance, Elsevier, vol. 36(4), pages 968-980.
    5. Guo, Xu & Wong, Wing-Keung & Zhu, Lixing, 2013. "An analysis of portfolio selection with multiplicative background risk," MPRA Paper 51331, University Library of Munich, Germany.
    6. Jiang, Chonghui & Ma, Yongkai & An, Yunbi, 2013. "International portfolio selection with exchange rate risk: A behavioural portfolio theory perspective," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 648-659.

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