Two-moment decision model for location-scale family with background asset

Abstract

This paper studies the impact of background risk on the indifference curve. We first study the shape of the indifference curves for the investment with background risk for risk averters, risk seekers, and risk-neutral investors. Thereafter, we study the comparative statics of the change in the shapes of the indifference curves when the means and the standard deviations of the returns of the financial asset and/or the background asset change. In addition, we draw inference on risk vulnerability and investment decisions in financial crises and bull and bear markets