Time Varying Risk Aversion
AbstractWe use a repeated survey of a large sample of clients of an Italian bank to measure possible changes in investors’ risk aversion following the 2008 financial crisis. We find that both a qualitative and a quantitative measure of risk aversion increase substantially after the crisis. These changes are correlated with changes in portfolio choices, but do not seem to be correlated with “standard” factors that affect risk aversion, such as wealth, consumption habit, and background risk. This opens the possibility that psychological factors might be driving it. To test whether a scary experience (as the financial crisis) can trigger large increases in risk aversion, we conduct a lab experiment. We find that indeed students who watched a scary video have a certainty equivalent that is 27% lower than the ones who did not. Following a sharp drop in stock prices,a fear model predicts that individuals should sell stocks, while the habit model has the opposite implications; people should actively buy stocks to bring the risky assets to the new optimal level. We show that after the drop in stock prices in 2008 individuals rebalanced their portfolio in a way consistent to a fear model.
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Bibliographic InfoPaper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1322.
Length: 52 pages
Date of creation: 2013
Date of revision: Sep 2013
Other versions of this item:
- D1 - Microeconomics - - Household Behavior
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-09-13 (All new papers)
- NEP-BAN-2013-09-13 (Banking)
- NEP-CBE-2013-09-13 (Cognitive & Behavioural Economics)
- NEP-RMG-2013-09-13 (Risk Management)
- NEP-UPT-2013-09-13 (Utility Models & Prospect Theory)
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