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Risk-Taking-Neutral Background Risk

29 Pages Posted: 30 Jan 2013  

Guenter Franke

University of Konstanz - Department of Economics

Harris Schlesinger

University of Alabama; CESifo (Center for Economic Studies and Ifo Institute)

Richard Stapleton

University of Manchester - Division of Accounting and Finance

Date Written: January 29, 2013

Abstract

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

Franke, Guenter and Schlesinger, Harris and Stapleton, Richard, Risk-Taking-Neutral Background Risk (January 29, 2013). CESifo Working Paper Series No. 4070. Available at SSRN: https://ssrn.com/abstract=2208424

Guenter Franke

University of Konstanz - Department of Economics ( email )

Fach 147
Konstanz, 78457
Germany
+49 7531 88 2545 (Phone)
+49 7531 88 3559 (Fax)

Harris Schlesinger (Contact Author)

University of Alabama ( email )

P.O. Box 870244
200 Alston Hall, Box 870224
Tuscaloosa, AL 35487
United States
205-348-7858 (Phone)
205-348-0590 (Fax)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Richard Stapleton

University of Manchester - Division of Accounting and Finance ( email )

Crawford House
Oxford Road
Manchester M13 9PL
United Kingdom

HOME PAGE: http://rstapleton.com/

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