Risk Management and Saving: On Income Effects and Background Risk

We study the interplay of intertemporal risk management and saving decisions. We define risk management broadly by allowing the activity to influence the severity of loss, the probability of loss, or both simultaneously. Due to the similar cost-benefit structure of risk management and saving decisions a substitution effect arises whose implications are analyzed for changes in income and background risk. Typically, the direct effects of exogenous variations on risk management and saving decisions go in the same direction but because of substitution net effects become a priori ambiguous. We resolve this ambiguity by deriving necessary and sufficient conditions to sign the comparative statics. Our paper highlights fundamental differences between singleand multi-instrument models which have broad implications for empirical and theoretical work.