Multiplicative Background Risk

Günter Franke (), Harris Schlesinger () and Richard C. Stapleton ()
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Harris Schlesinger: University of Alabama
Richard C. Stapleton: University of Manchester and University of Melbourne

No 03-05, CoFE Discussion Paper from Center of Finance and Econometrics, University of Konstanz

Abstract: Although there has been much attention in recent years on the effects of additive background risks, the same is not true for its multiplicative counterpart. We consider random wealth of the multiplicative form xy, where x and y are statistically independent random variables. We assume that x is endogenous to the economic agent, but that y is an exogenous and nontradable background risk, which represents a type of market incompleteness. Our main focus is on how the presence of the multiplicative background risk y affects risk-taking behavior for decisions on the choice of x. We characterize conditions on preferences that lead to more cautious behavior.

Keywords: multiplicative risks; background risk; incomplete markets; standard risk aversion; affiliated utility function; multiplicative risk vulnerability (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk, nep-rmg and nep-upt
Date: 2003-05
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