Variance Vulnerability, Background Risks, and Mean-Variance Preferences |
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Authors: | Thomas Eichner and Andreas Wagener |
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Institution: | (1) VWL IV, University of Siegen, FB 5, Hölderlinstr. 3, 57068 Siegen, Germany;(2) Department of Economics, University of Vienna, Hohenstaufengasse 9, 1010 Vienna, Austria |
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Abstract: | An agent with two-parameter, mean-variance preferences is called variance vulnerable if an increase in the variance of an exogenous, independent background risk induces the agent to choose a lower level of risky activities. Variance vulnerability resembles the notion of risk vulnerability in the expected utility (EU) framework. First, we characterize variance vulnerability in terms of two-parameter utility functions. Second, we identify the multivariate normal as the only distribution such that EU- and two-parameter approach are compatible when independent background risks prevail. Third, presupposing normality, we show that—analogously to risk vulnerability—temperance is a necessary, and standardness and convex risk aversion are sufficient conditions for variance vulnerability. |
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Keywords: | mean-variance preferences background risk variance vulnerability |
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