Risky asset allocation and consumption rule in the presence of background risk and insurance markets

► We examine the decisions of risky asset allocation and consumption rate in the presence of background risk. ► Optimal mix of risky assets will reflect an agent's risk attitude when background risk is related to investment risk. ► Optimal insurance will hedge investment risk and balance the growth and the volatility of consumption. ► The result can explain the asset allocation puzzle and the equity premium puzzle in the financial literature.