Portfolio Choice with a Correlated Background Risk : Theory and Evidence
AbstractWe extend the static portfolio choice problem with a small background risk to the case of small partially correlated background risks. We show that respecting the theories under which risk substitution appears, except for the independence of background risk, it is perfectly rational for the individual to increase his optimal exposure to portfolio risk when risks are partially negatively correlated. Then, we test empirically the hypothesis ofrisk substitutability using INSEE data on French households. We find that households respond by increasing their stockholdings in response to the increase in future earnings uncertainty. This conclusion is in contradictionwith results obtained in other countries. So, in light of these results, our model provides an explanation to account for the lack of empirical consensus on cross-country tests of risk substitution theory that encompasses and criticises all of them.
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Bibliographic InfoPaper provided by DELTA (Ecole normale supérieure) in its series DELTA Working Papers with number 2002-16.
Date of creation: 2002
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-03-19 (All new papers)
- NEP-FIN-2003-03-19 (Finance)
- NEP-MIC-2003-03-25 (Microeconomics)
- NEP-RMG-2003-03-19 (Risk Management)
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- Luc Arrondel & AndrÃ© Masson & Daniel Verger, 2005. "From Theory To An Original Methodological Survey," Economie et Statistique, Institut National de la Statistique et des Etudes Economiques, vol. 374, pages 21-51, May.
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Economics Papers from University Paris Dauphine
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- repec:hal:wpaper:halshs-00588069 is not listed on IDEAS
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