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Multiplicative background risk

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

No FS IV 02-06, Discussion Papers, various Research Units from WZB Berlin Social Science Center

Abstract: 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 uninsurable background risk. Our main focus is on how the randomness of y affects risk-taking behavior for decisions on the choice of x. We characterize conditions on preferences that lead to more cautious behavior. We also develop the concept of the affiliated utility function, which we define as the composition of the underlying utility function and the exponential function. This allows us to adapt several results for additive background risk to the multiplicative case.

Keywords: background risk; standard risk aversion; affiliated utility function (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
Date: 2002
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Journal Article: Multiplicative Background Risk (2006) Downloads
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