Risk aversion in the presence of background risk: Evidence from an economic experiment

This paper investigates whether individuals’ risk-taking behavior is affected by background risk by analyzing individuals’ choices over a series of lotteries in a laboratory setting in the presence and absence of independent, uncorrelated background risks. Overall, our results were mixed. We found some support for the notion that individuals were more risk averse when faced with the introduction of an unfair or mean-preserving background risk than when no background risk was present, but this finding depends on how individuals incorporate endowments and background gains and losses into their utility functions and how error variance is modeled.