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Risk-Taking-Neutral Background Risk

Günter Franke (), Harris Schlesinger and Richard C. Stapleton

No 4070, CESifo Working Paper Series from CESifo Group Munich

Abstract: We define a class of risk-taking-neutral (RTN) background risks. These background risks have the property that they will not alter decisions made with respect to another risk, for individuals with HARA utility. If we wish to compare a decision made with and without some exogenous background risk, it is often easier to compare the decision made to one made with a RTN background risk. We use this methodology to prove and extend a well-known theorem about dynamic investment strategy, due to Mossin (1968a). We also use this methodology to analyze investment behavior in the presence of an income tax as well as to analyze investment behavior in the presence of particular types of background risks.

Keywords: background risk; HARA utility; income tax; portfolio choice; risk vulnerability (search for similar items in EconPapers)
JEL-codes: D81 G11 (search for similar items in EconPapers)
Date: 2013
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