Risk-Taking-Neutral Background Risk
29 Pages Posted: 30 Jan 2013
Date Written: January 29, 2013
We define a class of risk-taking-neutral (RTN) background risks. These background risks have the property that they will not alter decisions made with respect to another risk, for individuals with HARA utility. If we wish to compare a decision made with and without some exogenous background risk, it is often easier to compare the decision made to one made with a RTN background risk. We use this methodology to prove and extend a well-known theorem about dynamic investment strategy, due to Mossin (1968a). We also use this methodology to analyze investment behavior in the presence of an income tax as well as to analyze investment behavior in the presence of particular types of background risks.
Keywords: background risk, HARA utility, income tax, portfolio choice, risk vulnerability
JEL Classification: D810, G110
Suggested Citation: Suggested Citation