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Risk Taking with Additive and Multiplicative Background Risks

Author

Listed:
  • Günter Franke

    (Department of Economics, University of Konstanz, Germany)

  • Harris Schlesinger

    (University of Alabama, USA)

  • Richard C. Stapleton

    (University of Manchester, UK)

Abstract

We examine the effects of background risks on optimal portfolio choice. Examples of background risks include uncertain labor income, uncertainty about the terminal value of fixed assets such as housing and uncertainty about future tax liabilities. While some of these risks are additive and have been amply studied, others are multiplicative in nature and have received far less attention. The simultaneous effect of both additive and multiplicative risks has hitherto not received attention and can explain some paradoxical choice behavior. We rationalize such behavior and show how background risks might lead to seemingly U-shaped relative risk aversion for a representative investor.

Suggested Citation

  • Günter Franke & Harris Schlesinger & Richard C. Stapleton, 2011. "Risk Taking with Additive and Multiplicative Background Risks," Working Paper Series of the Department of Economics, University of Konstanz 2011-25, Department of Economics, University of Konstanz.
    • Handle: RePEc:knz:dpteco:1125
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Derived risk aversion; Additive; multiplicative background risk;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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