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Standard Risk Aversion and the Demand for Risky Assets in the Presence of Background Risk

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  • Franke, Günter
  • Stapleton, Richard C.
  • Subrahmanyam, Marti G.

Abstract

We consider the demand for state contingent claims in the presence of a zero-mean, nonhedgeable background risk. An agent is defined to be generalized risk averse if he/she reacts to an increase in background risk by choosing a demand function for contingent claims with a smaller slope. We show that the conditions for standard risk aversion: positive, declining absolute risk aversion and prudence are necessary and sufficient for generalized risk aversion. We also derive anecessary and suÆcient condition for the agent's derived risk aversion to increase with a simple increase in background risk.

Suggested Citation

  • Franke, Günter & Stapleton, Richard C. & Subrahmanyam, Marti G., 2000. "Standard Risk Aversion and the Demand for Risky Assets in the Presence of Background Risk," CoFE Discussion Papers 00/36, University of Konstanz, Center of Finance and Econometrics (CoFE).
    • Handle: RePEc:zbw:cofedp:0036
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