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Two-moment decision model for location-scale family with background asset

  • Guo, Xu
  • Wong, Wing-Keung
  • Zhu, Lixing

This paper studies the impact of background risk on the indifference curve. We first study the shape of the indifference curves for the investment with background risk for risk averters, risk seekers, and risk-neutral investors. Thereafter, we study the comparative statics of the change in the shapes of the indifference curves when the means and the standard deviations of the returns of the financial asset and/or the background asset change. In addition, we draw inference on risk vulnerability and investment decisions in financial crises and bull and bear markets.

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File URL: http://mpra.ub.uni-muenchen.de/43864/1/MPRA_paper_43864.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 43864.

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Date of creation: 15 Jan 2013
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Handle: RePEc:pra:mprapa:43864
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  1. Zhidong Bai & Yongchang Hui & Wing-Keung Wong & Ričardas Zitikis, 2012. "Prospect Performance Evaluation: Making a Case for a Non-asymptotic UMPU Test," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 10(4), pages 703-732, September.
  2. EECKHOUDT, Louis & Christian GOLLIER & Harris SCHLESINGER, 1994. "Changes in Background Risk and Risk Taking Behavior," Working Papers 005, Risk and Insurance Archive.
  3. Feder, Gershon, 1977. "The impact of uncertainty in a class of objective functions," Journal of Economic Theory, Elsevier, vol. 16(2), pages 504-512, December.
  4. Wong, Wing-Keung, 2007. "Stochastic dominance and mean-variance measures of profit and loss for business planning and investment," European Journal of Operational Research, Elsevier, vol. 182(2), pages 829-843, October.
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  7. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  8. Thomas Eichner & Andreas Wagener, 2001. "More on Parametric Characterizations of Risk Aversion and Prudence," Volkswirtschaftliche Diskussionsbeiträge 99-01, Universität Siegen, Fakultät Wirtschaftswissenschaften, Wirtschaftsinformatik und Wirtschaftsrecht.
  9. Fong, Wai Mun & Wong, Wing Keung & Lean, Hooi Hooi, 2005. "International momentum strategies: a stochastic dominance approach," Journal of Financial Markets, Elsevier, vol. 8(1), pages 89-109, February.
  10. 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.
  11. Levy, Haim & Wiener, Zvi, 1998. "Stochastic Dominance and Prospect Dominance with Subjective Weighting Functions," Journal of Risk and Uncertainty, Springer, vol. 16(2), pages 147-63, May-June.
  12. Sandmo, Agnar, 1971. "On the Theory of the Competitive Firm under Price Uncertainty," American Economic Review, American Economic Association, vol. 61(1), pages 65-73, March.
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  14. Caballe, Jordi & Pomansky, Alexey, 1997. "Complete monotonicity, background risk, and risk aversion," Mathematical Social Sciences, Elsevier, vol. 34(3), pages 205-222, October.
  15. Meyer, Jack, 1987. "Two-moment Decision Models and Expected Utility Maximization," American Economic Review, American Economic Association, vol. 77(3), pages 421-30, June.
  16. Luc Arrondel & Hector Calvo Pardo & Xisco Oliver, 2010. "Temperance in Stock Market Participation: Evidence from France," Economica, London School of Economics and Political Science, vol. 77(306), pages 314-333, 04.
  17. Andreas Wagener, 2005. "Linear risk tolerance and mean-variance preferences," Economics Bulletin, AccessEcon, vol. 4(1), pages 1-8.
  18. 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.
  19. Eichner, Thomas & Wagener, Andreas, 2012. "Tempering effects of (dependent) background risks: A mean-variance analysis of portfolio selection," Journal of Mathematical Economics, Elsevier, vol. 48(6), pages 422-430.
  20. Moshe Levy & Haim Levy, 2002. "Prospect Theory: Much Ado About Nothing?," Management Science, INFORMS, vol. 48(10), pages 1334-1349, October.
  21. Haim Levy, 2004. "Prospect Theory and Mean-Variance Analysis," Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 1015-1041.
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