Standard Risk Aversion and the Demand for Risky Assets in the Presence of Background Risk
March 30, 1999
G. Franke, R.C. Stapleton and Marti G. Subrahmanyam
ABSTRACT
We consider the demand for state contingent claims in the presence of a zero-mean, non-hedgeable background risk.
An agent is defined to be generalized risk averse if he/she reacts to an increase in background risk by choosing
a demand function for contingent claims with a smaller slope. We show that the conditions for standard risk aversion:
positive, declining absolute risk aversion and prudence are necessary and sufficient for generalized risk aversion.
We also derive a necessary and sufficient condition for the agent's derived risk aversion to increase with a simple
increase in background risk.
Subject: Economics/Theory
Classification: Theoretical
Guenter Franke
Institution: Fakultat fur Wirtschaftswissenschaften und Statistik, University of Konstanz
Email: guenter.franke@uni-konstanz.de
R.C. Stapleton
Institution: Department of Accounting and Finance, University of Strathclyde
Email: rcs@staplet.demon.co.uk
Marti G. Subrahmanyam
Institution: Stern School of Business, New York University
Email: msubrahm@stern.nyu.edu
Telephone: (212) 998-0348
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