Financial Risk Taking in the Presence of Correlated Non-Financial Background Risk

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Abstract

This paper characterizes the stochastic deterioration resulting from taking a zero-mean financial risk in the presence of correlated non-financial background risk. We show in particular that it has an equivalent stochastic order as well as a necessary and sufficient "integral condition" that implies and is implied by a particular sense in which the stochastic deterioration can be decomposed into a "correlation increase" and a "marginal risk increase". We further characterize a measure of aversion to the stochastic deterioration. These characterizations provide for a more general framework for formulating concepts of increases in risk and correlation and for better understanding risk management decisions governed by individuals' attitudes to them.
Original languageEnglish
Pages (from-to)167-179
Number of pages12
JournalJournal of Mathematical Economics
Volume88
Early online date2 Apr 2020
DOIs
Publication statusE-pub ahead of print - 2 Apr 2020

Keywords

  • non-financial background risk, expectation dependence, portfolio choice, correlation aversion, correlated risks, marginal risk increase

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