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Multiplicative Background Risk

  • Günter Franke

    ()

    (Department of Economics, University of Konstanz)

  • Harris Schlesinger

    ()

    (University of Alabama)

  • Richard C. Stapleton

    ()

    (University of Manchester and University of Melbourne)

Although there has been much attention in recent years on the effects of additive background risks, the same is not true for its multiplicative counterpart. We consider random wealth of the multiplicative form xy, where x and y are statistically independent random variables. We assume that x is endogenous to the economic agent, but that y is an exogenous and nontradable background risk, which represents a type of market incompleteness. Our main focus is on how the presence of the multiplicative background risk y affects risk-taking behavior for decisions on the choice of x. We characterize conditions on preferences that lead to more cautious behavior.

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Paper provided by Center of Finance and Econometrics, University of Konstanz in its series CoFE Discussion Paper with number 03-05.

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Length: 33 pages
Date of creation: May 2003
Date of revision:
Handle: RePEc:knz:cofedp:0305
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