Higher-order risk vulnerability

James Huang () and Richard Stapleton
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James Huang: Lancaster University Management School
Richard Stapleton: Manchester Business School, Crawford House

Economic Theory, 2017, vol. 63, issue 2, No 2, 387-406

Abstract: Abstract We add an independent unfair background risk to higher-order risk-taking models in the current literature and examine its interaction with the main risk under consideration. Parallel to the well-known concept of risk vulnerability, which is defined by Gollier and Pratt (Econometrica 64:1109–1123, 1996), an agent is said to have a type of higher-order risk vulnerability if adding an independent unfair background risk to wealth raises his level of this type of higher-order risk aversion. We derive necessary and sufficient conditions for all types of higher-order risk vulnerabilities and explain their behavioral implications. We find that as in the case of risk vulnerability, all familiar HARA utility functions have all types of higher-order risk vulnerabilities except for a type of third-order risk vulnerability corresponding to a downside risk aversion measure called the Schwarzian derivative.

Keywords: Background risk; Downside risk aversion; Downside risk vulnerability; Higher-order risk vulnerability (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s00199-015-0935-2

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