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Incremental Risk Vulnerability

  • Günter Franke

    ()

    (Department of Economics, University of Konstanz)

  • Richard C. Stapleton

    ()

    (University of Manchester and University of Melbourne)

  • Marti G. Subrahmanyam

    ()

    (Stern School of Business, New York University)

We present a necessary and sufficient condition on an agent’s utility function for a simple mean preserving spread in an independent background risk to increase the agent’s risk aversion (incremental risk vulnerability). Gollier and Pratt (1996) have shown that declining and convex risk aversion as well as standard risk aversion are sufficient for risk vulnerability. We show that these conditions are also sufficient for incremental risk vulnerability. In addition, we present sufficient conditions for a restricted set of stochastic increases in an independent background risk to increase risk aversion.

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Paper provided by Center of Finance and Econometrics, University of Konstanz in its series CoFE Discussion Paper with number 05-08.

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Length: 19 pages
Date of creation: 23 Sep 2005
Date of revision:
Handle: RePEc:knz:cofedp:0508
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  1. Miles S. Kimball, 1991. "Standard Risk Aversion," NBER Technical Working Papers 0099, National Bureau of Economic Research, Inc.
  2. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, vol. 55(1), pages 143-54, January.
  3. Diamond, Peter A. & Stiglitz, Joseph E., 1974. "Increases in risk and in risk aversion," Journal of Economic Theory, Elsevier, vol. 8(3), pages 337-360, July.
  4. Donald J. Meyer & Jack Meyer, 1998. "Changes in Background Risk and the Demand for Insurance," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 23(1), pages 29-40, June.
  5. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, vol. 49(4), pages 911-20, June.
  6. Donald C. Keenan & Arthur Snow, 2003. "Locally Greater Vulnerability to Background Risk," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 28(2), pages 161-172, December.
  7. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  8. EECKHOUDT, Louis & Christian GOLLIER & Harris SCHLESINGER, 1994. "Changes in Background Risk and Risk Taking Behavior," Working Papers 005, Risk and Insurance Archive.
  9. Gollier, Christian & John W. PRATT, 1993. "Weak Proper Risk Aversion And The Tempering Effect of Background Risk," Working Papers 018, Risk and Insurance Archive.
  10. Nachman, David C., 1982. "Preservation of "more risk averse" under expectations," Journal of Economic Theory, Elsevier, vol. 28(2), pages 361-368, December.
  11. Thomas Eichner & Andreas Wagener, 2003. "Variance Vulnerability, Background Risks, and Mean-Variance Preferences," The Geneva Risk and Insurance Review, Palgrave Macmillan, vol. 28(2), pages 173-184, December.
  12. 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.
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