We examine the optimal risk-taking behaviour of a risk-averse individual under the assumption of a guaranteed floor for wealth (limited liability). We show that the existence of limited liability raises the optimal exposure to risk. Also, there is a positive lower bound to initial wealth (equity) under which it is optimal to accept the maximum allowed risk (''betting for ressurection''). An exogenous increase in equity does not necessarily reduces optimal exposure to risk, except if absolute risk aversion is non- decreasing. In particular, we show that increasing equity capital would increase the probability of failure if relative risk aversion is decreasing. Applications are for the regulation of the banking and insurance systems with incomplete markets and asymmetric information.
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Paper provided by Risk and Insurance Archive in its series Working Papers with number
016.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Dionne, Georges & Eeckhoudt, Louis & Gollier, Christian, 1993.
"Increases in Risk and Linear Payoffs,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(2), pages 309-19, May.
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