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Cross Risk Apportionment and Non-financial Correlated Background Uncertainty

Author

Listed:
  • Takao Asano

    (Okayama University)

  • Yusuke Osaki

    (Waseda University)

Abstract

This paper considers a portfolio problem with one safe asset and one risky asset in the presence of background risk. We assume that the background risk is a non-financial variable and it is correlated to financial risk. The aim of this paper is to investigate the effect of correlation on portfolio choices. While we find that an increase in correlation lowers (raises) the expected utility for mixed correlation averse (seeking) individuals, contrary to intuition, it does not necessarily reduce (increase) the investment in the risky asset. We determine the conditions needed to reduce (increase) the investment and find that these conditions can be related to cross risk apportionment, which is the type of preferences for the combination of good and bad. We also introduce ambiguity into the correlation and investigate its effects on the portfolio choices.

Suggested Citation

  • Takao Asano & Yusuke Osaki, 2023. "Cross Risk Apportionment and Non-financial Correlated Background Uncertainty," KIER Working Papers 1098, Kyoto University, Institute of Economic Research.
    • Handle: RePEc:kyo:wpaper:1098
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    References listed on IDEAS

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    More about this item

    Keywords

    Ambiguity; Bivariate Utility Function; Linear Payoff; Mixed Correlation Aversion (Seekingness); Background Uncertainty; Portfolio Choice;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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