Franke, Günter Schlesinger, Harris Stapleton, Richard C.
Year of Publication:
CoFE Discussion Paper No. 03/05
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 xy, where x and y are statistically independent random variables. We assume that y is endogenous to the economic agent, but that is an exogenous and nontradable background risk, which represents a type of market incompleteness. Our main focus is on how the presence of the multiplicative background risk y affects risk-taking behavior for decisions on the choice of x. We characterize conditions on preferences that lead to more cautious behavior.
multiplicative risk background risk incomplete markets standard risk aversion affiliated utility function multiplicative risk vulnerability