Multiplicative background risk

Günter Franke; Harris Schlesinger; Richard C. Stapleton

doi:10.1287/mnsc.1050.0450

Multiplicative background risk

Günter Franke, Harris Schlesinger, Richard C. Stapleton

Accounting and Finance division

Research output: Contribution to journal › Article › peer-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 language	English
Pages (from-to)	146-153
Number of pages	7
Journal	MANAGEMENT SCIENCE
Volume	52
Issue number	1
DOIs	https://doi.org/10.1287/mnsc.1050.0450
Publication status	Published - Jan 2006

Keywords

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

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10.1287/mnsc.1050.0450

http://www.extenza-eps.com/INF/doi/pdf/10.1287/mnsc.1050.0450

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AU - Stapleton, Richard C.

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AB - 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.

KW - Affiliated utility function

KW - Background risk

KW - Diffidence theorem

KW - Multiplicative risk vulnerability

KW - Multiplicative risks

KW - Risk vulnerability

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DO - 10.1287/mnsc.1050.0450

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VL - 52

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JO - MANAGEMENT SCIENCE

JF - MANAGEMENT SCIENCE

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Multiplicative background risk

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