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The demand for a risky asset in the presence of a background risk

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  • Li, Jingyuan

Abstract

We examine the demand for a risky asset in the presence of two risks: a financial risk and a background risk which need not be financial. First, we compute the necessary and sufficient condition for a positive demand for a risky asset, showing that it depends on two terms capturing respectively the direct effect of risk premium and the dependence between the two risks. Second, we develop higher order expectation dependence concept and show that the more information about the sign of higher cross derivatives of the utility function we have, the weaker dependence conditions on distribution we achieve.

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  • Li, Jingyuan, 2011. "The demand for a risky asset in the presence of a background risk," Journal of Economic Theory, Elsevier, vol. 146(1), pages 372-391, January.
  • Handle: RePEc:eee:jetheo:v:146:y:2011:i:1:p:372-391
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Dionne, Georges & Li, Jingyuan, 2014. "Comparative Ross risk aversion in the presence of mean dependent risks," Journal of Mathematical Economics, Elsevier, vol. 51(C), pages 128-135.
    2. Alghalith, Moawia, 2012. "The impact of background risk," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 391(24), pages 6506-6508.
    3. Bontems, Philippe & Nauges, Céline, 2017. "Production choices with water markets: The role of initial allocations and forward trading," TSE Working Papers 17-812, Toulouse School of Economics (TSE).
    4. Michel M. Denuit & Louis Eeckhoudt, 2016. "Risk aversion, prudence, and asset allocation: a review and some new developments," Theory and Decision, Springer, vol. 80(2), pages 227-243, February.
    5. Georges Dionne & Jingyuan Li & Cedric Okou, 2012. "An Extension of the Consumption-based CAPM Model," Cahiers de recherche 1214, CIRPEE.
    6. Wong, Kit Pong, 2013. "Fixed versus variable rate loans under state-dependent preferences," Economic Modelling, Elsevier, vol. 31(C), pages 659-663.
    7. Li, Jingyuan & Liu, Dongri & Wang, Jianli, 2016. "Risk aversion with two risks: A theoretical extension," Journal of Mathematical Economics, Elsevier, vol. 63(C), pages 100-105.
    8. Michel Denuit & Rachel Huang & Larry Tzeng, 2015. "Almost expectation and excess dependence notions," Theory and Decision, Springer, vol. 79(3), pages 375-401, November.
    9. Dionne, Georges & Harrington, Scott, 2017. "Insurance and Insurance Markets," Working Papers 17-2, HEC Montreal, Canada Research Chair in Risk Management.
    10. Moawia Alghalith & Xu Guo & Wing-Keung Wong & Lixing Zhu, 2016. "A General Optimal Investment Model In The Presence Of Background Risk," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 11(01), pages 1-8, March.
    11. James Huang & Richard Stapleton, 2017. "Higher-order risk vulnerability," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(2), pages 387-406, February.
    12. Kit Wong, 2014. "Hedging and the competitive firm under correlated price and background risk," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 37(2), pages 329-340, October.
    13. Huang, James, 2014. "Convex and decreasing absolute risk aversion is proper," Economics Letters, Elsevier, vol. 125(1), pages 123-125.
    14. Kit Wong, 2014. "Production and hedging in futures markets with multiple delivery specifications," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 37(2), pages 413-421, October.
    15. Denuit, Michel M. & Mesfioui, Mhamed, 2017. "Preserving the Rothschild–Stiglitz type increase in risk with background risk: A characterization," Insurance: Mathematics and Economics, Elsevier, vol. 72(C), pages 1-5.
    16. Guo, Xu & Li, Jingyuan, 2016. "Confidence band for expectation dependence with applications," Insurance: Mathematics and Economics, Elsevier, vol. 68(C), pages 141-149.
    17. Udo Broll & Peter Welzel & Kit Wong, 2015. "Futures hedging with basis risk and expectation dependence," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 62(3), pages 213-221, September.
    18. Xuehu Zhu & Xu Guo & Lu Lin & Lixing Zhu, 2016. "Testing for positive expectation dependence," Annals of the Institute of Statistical Mathematics, Springer;The Institute of Statistical Mathematics, vol. 68(1), pages 135-153, February.
    19. Georges Dionne & Jingyuan Li, 2012. "Comparative Ross Risk Aversion in the Presence of Quadrant Dependent Risks," Cahiers de recherche 1226, CIRPEE.
    20. Catherine Eckel & Philip Grossman & Cathleen Johnson & Angela Oliveira & Christian Rojas & Rick Wilson, 2012. "School environment and risk preferences: Experimental evidence," Journal of Risk and Uncertainty, Springer, vol. 45(3), pages 265-292, December.
    21. Donatella Baiardi & Marco Magnani & Mario Menegatti, 2014. "Precautionary saving under many risks," Journal of Economics, Springer, vol. 113(3), pages 211-228, November.
    22. Okou, Cedric & Maalaoui Chun, Olfa & Dionne, Georges & Li, Jingyuan, 2016. "Can Higher-Order Risks Explain the Credit Spread Puzzle?," Working Papers 16-1, HEC Montreal, Canada Research Chair in Risk Management.
    23. Udo Broll & Kit Wong, 2015. "The impact of inflation risk on forward trading and production," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 14(1), pages 65-73, December.
    24. Guo, Xu & Li, Jingyuan & Liu, Dongri & Wang, Jianli, 2016. "Preserving the Rothschild–Stiglitz type of increasing risk with background risk," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 144-149.
    25. Guo, Xu & Wong, Wing-Keung & Zhu, Lixing, 2013. "An analysis of portfolio selection with multiplicative background risk," MPRA Paper 51331, University Library of Munich, Germany.

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