Cross Risk Apportionment and Non-financial Correlated Background Uncertainty

Takao Asano () and Yusuke Osaki ()
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Takao Asano: Okayama University
Yusuke Osaki: Waseda University

No 1098, KIER Working Papers from Kyoto University, Institute of Economic Research

Abstract: This paper considers a portfolio problem with one safe asset and one risky asset in the presence of background risk. We assume that the background risk is a non-financial variable and it is correlated to financial risk. The aim of this paper is to investigate the effect of correlation on portfolio choices. While we find that an increase in correlation lowers (raises) the expected utility for mixed correlation averse (seeking) individuals, contrary to intuition, it does not necessarily reduce (increase) the investment in the risky asset. We determine the conditions needed to reduce (increase) the investment and find that these conditions can be related to cross risk apportionment, which is the type of preferences for the combination of good and bad. We also introduce ambiguity into the correlation and investigate its effects on the portfolio choices.

Keywords: Ambiguity; Bivariate Utility Function; Linear Payoff; Mixed Correlation Aversion (Seekingness); Background Uncertainty; Portfolio Choice (search for similar items in EconPapers)
JEL-codes: D81 D91 G11 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2023-11
New Economics Papers: this item is included in nep-rmg and nep-upt
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