Multiplicative Background Risk

Multiplicative Background Risk by Günter Franke, Harris Schlesinger, Richard C. Stapleton We consider random wealth of the multiplicative form x ỹ, where x and ỹ are statistically independent random variables. We assume that x  is endogenous to the economic agent, but that ỹ is an exogenous and uninsurable background risk. Our main focus is on how the randomness of ỹ affects risk-taking behavior for decisions on the choice of x. We characterize conditions on preferences that lead to more cautious behavior. We also develop the concept of the affiliated utility function, which we define as the composition of the underlying utility function and the exponential function. This allows us to adapt several results for additive background risk to the multiplicative case.