Risk taking with additive and multiplicative background risks
AbstractWe examine the effects of background risks on optimal portfolio choice. Examples of background risks include uncertain labor income, uncertainty about the terminal value of fixed assets such as housing and uncertainty about future tax liabilities. While some of these risks are additive and have been amply studied, others are multiplicative in nature and have received far less attention. The simultaneous effect of both additive and multiplicative risks has hitherto not received attention and can explain some paradoxical choice behavior. We rationalize such behavior and show how background risks might lead to seemingly U-shaped relative risk aversion for a representative investor.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Economic Theory.
Volume (Year): 146 (2011)
Issue (Month): 4 (July)
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Web page: http://www.elsevier.com/locate/inca/622869
Derived risk aversion Additive; multiplicative background risk;
Other versions of this item:
- Günter Franke & Harris Schlesinger & Richard C. Stapleton, 2011. "Risk Taking with Additive and Multiplicative Background Risks," Working Paper Series of the Department of Economics, University of Konstanz 2011-25, Department of Economics, University of Konstanz.
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
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