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Effects of Background Risks on Cautiousness with an Application to a Portfolio Choice Problem

  • Hara, Chiaki
  • Huang, James
  • Kuzmics, Christoph

We provide a necessary and a sufficient condition on an individual's expected utility function under which any zero-mean idiosyncratic risk increases cautiousness (the derivative of the reciprocal of the absolute risk aversion), which is the key determinant for this individual's demand for options and portfolio insurance.

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Paper provided by Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University in its series PIE/CIS Discussion Paper with number 368.

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Length: 25 p.
Date of creation: Mar 2008
Date of revision:
Handle: RePEc:hit:piecis:368
Note: "March 31, 2008" -- Title page
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  1. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, vol. 49(4), pages 911-20, June.
  2. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  3. Hara, Chiaki & Huang, James & Kuzmics, Christoph, 2007. "Representative Consumer's Risk Aversion and Efficient Risk-Sharing Rules," Discussion Paper 323, Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University.
  4. Gollier, Christian & Pratt, John W, 1996. "Risk Vulnerability and the Tempering Effect of Background Risk," Econometrica, Econometric Society, vol. 64(5), pages 1109-23, September.
  5. Leland, Hayne E, 1980. " Who Should Buy Portfolio Insurance?," Journal of Finance, American Finance Association, vol. 35(2), pages 581-94, May.
  6. Brennan, M.J. & Solanki, R., 1981. "Optimal Portfolio Insurance," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(03), pages 279-300, September.
  7. Marti G. Subrahmanyam & G√ľnter Franke & Richard C. Stapleton, 1998. "Who Buys and Who Sells Options: The Role and Pricing of Options in an Economy with Background Risk," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-063, New York University, Leonard N. Stern School of Business-.
  8. Franke, Gunter & Stapleton, Richard C. & Subrahmanyam, Marti G., 1998. "Who Buys and Who Sells Options: The Role of Options in an Economy with Background Risk," Journal of Economic Theory, Elsevier, vol. 82(1), pages 89-109, September.
  9. Miles S. Kimball, 1991. "Precautionary Motives for Holding Assets," NBER Working Papers 3586, National Bureau of Economic Research, Inc.
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