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Changes in multiplicative background risk and risk-taking behavior

Abstract

This article analyzes the conditions under which any change in a multiplicative background risk induces a more cautious behavior. We give necessary and sufficient conditions under which any change in the multiplicative background risk with respect to the Nth-degree stochastic dominance raises local risk aversion. Surprisingly, decreasing relative risk aversion of any order up to N in the sense of Pratt (Econometrica 32:122–136, 1964) coupled with decreasing relative risk aversion in the sense of Ross (Econometrica 49:631–638, 1981) are sufficient to guarantee an increase in local risk aversion after any deterioration of the multiplicative background risk thanks to the Nth-degree stochastic dominance. We link our results concerning second-order stochastic dominance with the concept of multiplicative risk vulnerability.

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Correspondence to Octave Jokung.

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Jokung, O. Changes in multiplicative background risk and risk-taking behavior. Theory Decis 74, 127–149 (2013). https://doi.org/10.1007/s11238-012-9336-1

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  • DOI: https://doi.org/10.1007/s11238-012-9336-1

Keywords

  • Background risk
  • Comparative risk
  • Increase in risk
  • Risk aversion
  • Risk vulnerability
  • Stochastic dominance

JEL Classification

  • D81