Risk Taking with Background Risk under Recursive Rank-Dependent Utility

This paper examines how background risk affects risk taking under rank-dependent utility. I assume that a decision-maker facing a risk taking decision in the presence of background risk views these risks as composing a compound lottery, and recursively evaluates this compound lottery using rank-dependent utility. I show that adding background risk increases risk aversion whenever the utility-for-wealth function is risk vulnerable (Gollier and Pratt, 1996) in this model.