2018-06, Franke, Günter, Schlesinger, Harris, Stapleton, Richard C.

This article examines how decision making under uncertainty is affected by the presence of a linearly dependent background risk, for individuals with HARA utility. A linearly dependent background risk is a background risk that increases linearly in the chosen tradable outcome. In order to do this, we construct a parametric class of background risks that we label as risk‐taking‐neutral (RTN). These background risks have the property that they will not alter the decision made with respect to the market risk. As such, these RTN background risks provide a benchmark. In many situations, a background risk that is faced by an investor can be compared to one from the RTN class in order to predict qualitative changes in the investor's choice decision. As this benchmark is easily available, it is convenient to use to predict these changes.

2011, Franke, Günter, Schlesinger, Harris, Stapleton, Richard C.

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.

2003, Franke, Günter, Schlesinger, Harris, Stapleton, Richard C.

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 x is endogenous to the economic agent, but that y 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

2011, Franke, Günter, Schlesinger, Harris, Stapleton, Richard

This paper examines how decision making under uncertainty is a ected by the presence of a background risk. By background risk, we refer to a risk for which there is no market for trading or hedging. In particular, we construct a class of background risks that we label as risk-taking-neutral (RTN). These background risks have the property that they will not alter the choice de- cisions made with respect to another risk. As such, these RTN background risks can provide a benchmark. In many situations, a background risk that is faced by an investor can be compared to one from the RTN class in order to predict qualitative changes in the investor's choice decision. In particular, we illustrate our benchmarking with three examples with regards to portfolio choice: (1) e ects of a at-rate income tax, (2) e ects of an independent non{ positive-mean background risk, and (3) a theorem about dynamic investing due to Mossin (1968a).

2008, Fei, Wenan, Schlesinger, Harris

This article considers a zero-mean background risk that is uncorrelated with insurable losses, but is not necessarily statistically independent. In particular, the size of the background risk can vary in different insurable-loss states. We show how a prudent individual will buy either more insurance or less insurance than with no background risk, depending on the relative size of the background risk in the loss states vis-á-vis the no-loss states. If we consider two individuals, with one more risk averse than the other, we need to compare the intensities of their precautionary motives, in addition to their measures of risk aversion, before we can determine who buys more insurance coverage in the presence of the state dependent background risk.

2011, Franke, Günter, Schlesinger, Harris, Stapleton, Richard C.

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.

2007, Franke, Günter, Schlesinger, Harris, Stapleton, Richard C.

We examine the effects of non-portfolio risks on optimal portfolio choice. Examples of non-portfolio risks include, among others, uncertain labor income, uncertainty about the terminal value of fixed assets such as housing and uncertainty about future tax liabilities. In particular, while some of these risks are added to portfolio value and have been amply studied, others are multiplicative in nature and have received far less attention. Moreover, the combined effects of multiple risks lead to some seemingly paradoxical choice behavior. We rationalize such behavior and we show how non-portfolio risks might lead to seemingly U-shaped relative risk aversion for a representative investor, as found empirically by Ait-Sahilia and Lo (2000) and Jackwerth (2000).