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 InfoPaper provided by Department of Economics, University of Konstanz in its series Working Paper Series of the Department of Economics, University of Konstanz with number 2011-25.
Length: 42 pages
Date of creation: 16 Jun 2011
Date of revision:
Other versions of this item:
- Franke, Guenter & Schlesinger, Harris & Stapleton, Richard C., 2011. "Risk taking with additive and multiplicative background risks," Journal of Economic Theory, Elsevier, vol. 146(4), pages 1547-1568, July.
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ACC-2011-07-02 (Accounting & Auditing)
- NEP-ALL-2011-07-02 (All new papers)
- NEP-SOG-2011-07-02 (Sociology of Economics)
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