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

  • Chiaki Hara

    ()

    (Institute of Economic Research, Kyoto University)

  • James Huang

    ()

    (Department of Accounting and Management, Lancaster University Management School)

  • Christoph Kuzmics

    ()

    (MEDS, Kellogg School of Management, Northwestern University)

We provide necessary and sufficient conditions 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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File URL: http://www.kier.kyoto-u.ac.jp/DP/DP654.pdf
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Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 654.

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Length: 27pages
Date of creation: Jun 2008
Date of revision:
Handle: RePEc:kyo:wpaper:654
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  1. 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.
  2. 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.
  3. 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.
  4. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
  5. 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.
  6. 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-.
  7. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, vol. 49(4), pages 911-20, June.
  8. Miles S. Kimball, 1991. "Precautionary Motives for Holding Assets," NBER Working Papers 3586, National Bureau of Economic Research, Inc.
  9. Hayne E. Leland., 1979. "Who Should Buy Portfolio Insurance?," Research Program in Finance Working Papers 95, University of California at Berkeley.
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