Changes in background risk and risk taking behavior. (English) Zbl 0849.90002

Eeckhoudt, Louis; Gollier, Christian; Schlesinger, Harris

Econometrica 64, No. 3, 683-689 (1996).

We consider the effects of changes in the distribution of a background risk on the optimal risk taking behavior of a risk-averse decision maker. In particular, we suppose that the background risk deteriorates via a first- or second-degree stochastic dominance shift. Our contention is that such a change in background wealth should lead the individual to behave in a more risk-averse manner. We identify necessary and sufficient conditions for a deterioration in background wealth to increase the index of absolute risk aversion, either for FSD or SSD shifts in distribution. These conditions place restrictions on the stronger measure of risk aversion defined by Ross (1981).

Reviewer: L.Eeckhoudt (Mons, Belgium)

MSC:

91B06

Decision theory

Keywords:

distribution of a background risk; optimal risk taking behavior; risk-averse decision maker; stochastic dominance shift