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Risk Taking with Additive and Multiplicative Background Risks

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

No 2011-25, Working Paper Series of the Department of Economics, University of Konstanz from Department of Economics, University of Konstanz

Abstract: We examine the effects of background risks on optimal portfolio choice. Examples of background risks include uncertain labor income, uncertainty about the terminal value of fixed assets such as housing and uncertainty about future tax liabilities. While some of these risks are additive and have been amply studied, others are multiplicative in nature and have received far less attention. The simultaneous effect of both additive and multiplicative risks has hitherto not received attention and can explain some paradoxical choice behavior. We rationalize such behavior and show how background risks might lead to seemingly U-shaped relative risk aversion for a representative investor.

Keywords: Derived risk aversion; Additive; multiplicative background risk (search for similar items in EconPapers)
JEL-codes: D81 G11 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2011-06-16
New Economics Papers: this item is included in nep-acc and nep-sog
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Journal Article: Risk taking with additive and multiplicative background risks (2011) Downloads
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