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Portfolio choice with a correlated background risk : theory and evidence

Portfolio choice with a correlated background risk : theory and evidence
Portfolio choice with a correlated background risk : theory and evidence
In this paper, we extend the static portfolio choice problem with a small background risk to the case of small partially correlated background risks. We show that respecting the theories under which risk substitution appears, except for the independence of background risk, it is perfectly rational for the individual to increase his optimal exposure to portfolio risk when risks are partially negatively correlated. Then, we test empirically the hypothesis of risk substitutability using French households data. We found that households respond by increasing their stockholdings in response to the increase in future earnings uncertainty. This conclusion is in contradiction with results obtained in other countries.
So, in light of these results, our model provides an explanation to account for the lack of empirical consensus on cross-country tests of risk substitution theory that encompasses and criticises all of them.
2002-16
Centre National de la Recherche Scientifique, École Normale Supérieure
Arrondel, Luc
51a6cd5b-0df0-453f-b29e-09fd5dee03fa
Calvo-Pardo, Hector
07a586f0-48ec-4049-932e-fb9fc575f59f
Arrondel, Luc
51a6cd5b-0df0-453f-b29e-09fd5dee03fa
Calvo-Pardo, Hector
07a586f0-48ec-4049-932e-fb9fc575f59f

Arrondel, Luc and Calvo-Pardo, Hector (2002) Portfolio choice with a correlated background risk : theory and evidence (DELTA Working Paper Series, , (doi:10.2139/ssrn.996444), 2002-16) Paris, France. Centre National de la Recherche Scientifique, École Normale Supérieure 36pp.

Record type: Monograph (Working Paper)

Abstract

In this paper, we extend the static portfolio choice problem with a small background risk to the case of small partially correlated background risks. We show that respecting the theories under which risk substitution appears, except for the independence of background risk, it is perfectly rational for the individual to increase his optimal exposure to portfolio risk when risks are partially negatively correlated. Then, we test empirically the hypothesis of risk substitutability using French households data. We found that households respond by increasing their stockholdings in response to the increase in future earnings uncertainty. This conclusion is in contradiction with results obtained in other countries.
So, in light of these results, our model provides an explanation to account for the lack of empirical consensus on cross-country tests of risk substitution theory that encompasses and criticises all of them.

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Published date: July 2002

Identifiers

Local EPrints ID: 47461
URI: http://eprints.soton.ac.uk/id/eprint/47461
PURE UUID: 53d811a4-eb02-44b6-91d5-3fbb450190aa
ORCID for Hector Calvo-Pardo: ORCID iD orcid.org/0000-0001-6645-4273

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Date deposited: 01 Aug 2007
Last modified: 14 Mar 2019 01:41

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