Multiplicative background risk

Günter Franke, Harris Schlesinger, Richard C. Stapleton

Research output: Contribution to journalArticlepeer-review

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 x̃ ỹ, where x̃ and ỹ are statistically independent random variables. We assume that x̃ is endogenous to the economic agent but that ỹ is an exogenous and nontradable background risk that represents a type of market incompleteness. Our main focus is on how the presence of the multiplicative background risk ỹ affects risk-taking behavior for decisions on the choice of x̃. We extend the results of Gollier and Pratt (1996) to characterize conditions on preferences that lead to more cautious behavior. © 2006 INFORMS.
Original languageEnglish
Pages (from-to)146-153
Number of pages7
JournalMANAGEMENT SCIENCE
Volume52
Issue number1
DOIs
Publication statusPublished - Jan 2006

Keywords

  • Affiliated utility function
  • Background risk
  • Diffidence theorem
  • Multiplicative risk vulnerability
  • Multiplicative risks
  • Risk vulnerability

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