We examine the effects of background risks on optimal portfolio choice. Examples of background risks include uncertain labor income, uncertainty about the terminal value of fixed assets such as housing and uncertainty about future tax liabilities. While some of these risks are additive and have...

Consider a simple two-state risk with equal probabilities for the two states. In particular, assume that the random wealth variable dominates via ith-order stochastic dominance for i=M,N. We show that the 50-50 lottery dominates the lottery via (N+M)th-order stochastic dominance. The basic idea...