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Increased Risk-Bearing with Background Risk

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  • Gollier Christian

    () (U of Toulouse)

  • Schlee Edward E

    () (Arizona State University)

Abstract

Analyses of risk-bearing often assume that agents face only one risk. Agents however usually face several risks and the interaction between them can affect the willingness to bear any one of them. We consider how the introduction of background risk affects the comparative statics predictions of distribution changes in the standard two asset portfolio model. We show that such predictions are fairly robust, no matter what the correlation between the two risks. We consider changes in the conditional distributions of the risky asset's return; and changes in the marginal distribution of the asset's return. For the first question, a version of Gollier's (1995) Central Riskiness order is sufficient and necessary to increase risk-bearing. For the second question, Monotone Likelihood Ratio improvements are sufficient and necessary. Many of our proofs illustrate the "basis" approach to comparative statics under uncertainty.

Suggested Citation

  • Gollier Christian & Schlee Edward E, 2006. "Increased Risk-Bearing with Background Risk," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 6(1), pages 1-29, March.
  • Handle: RePEc:bpj:bejtec:v:topics.6:y:2006:i:1:n:3
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    References listed on IDEAS

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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. Barbara Pfeffer, 2006. "Trade Policy and Risk Diversification," Volkswirtschaftliche Diskussionsbeiträge 126-06, Universität Siegen, Fakultät Wirtschaftswissenschaften, Wirtschaftsinformatik und Wirtschaftsrecht.

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    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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