Financial Risk Taking in the Presence of Correlated Non-Financial Background Risk

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Abstract

This paper characterizes the stochastic deterioration resulting from taking a zero-mean financial risk in the presence of correlated non-financial background risk. We show in particular that it has an equivalent stochastic order as well as a necessary and sufficient "integral condition" that implies and is implied by a particular sense in which the stochastic deterioration can be decomposed into a "correlation increase" and a "marginal risk increase". We further characterize a measure of aversion to the stochastic deterioration. These characterizations provide for a more general framework for formulating concepts of increases in risk and correlation and for better understanding risk management decisions governed by individuals' attitudes to them.

Bibliographical metadata

Original languageEnglish
Pages (from-to)167-179
Number of pages12
JournalJournal of Mathematical Economics
Volume88
Early online date2 Apr 2020
DOIs
Publication statusE-pub ahead of print - 2 Apr 2020

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