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Time Varying Risk Aversion

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  • Luigi Guiso

    (EIEF and CEPR)

  • Paola Sapienza

    (Northwestern University, NBER and CEPR)

  • Luigi Zingales

    (University of Chicago, NBER and CEPR)

Abstract

We 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 Info

Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1322.

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Length: 52 pages
Date of creation: 2013
Date of revision: Sep 2013
Handle: RePEc:eie:wpaper:1322

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  1. Charles A. Holt & Susan K. Laury, 2002. "Risk Aversion and Incentive Effects," American Economic Review, American Economic Association, vol. 92(5), pages 1644-1655, December.
  2. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February.
  3. Luigi Guiso & Monica Paiella, 2003. "Risk Aversion, Wealth and Background Risk," Temi di discussione (Economic working papers) 483, Bank of Italy, Economic Research and International Relations Area.
  4. Ulrike Malmendier & Stefan Nagel, 2011. "Depression Babies: Do Macroeconomic Experiences Affect Risk Taking?," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 373-416.
  5. Yosef Bonaparte & Russell Cooper, 2010. "Costly Portfolio Adjustment," Economics Working Papers ECO2010/19, European University Institute.
  6. George Loewenstein, 2000. "Emotions in Economic Theory and Economic Behavior," American Economic Review, American Economic Association, vol. 90(2), pages 426-432, May.
  7. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  8. Knutson, Brian & Wimmer, G. Elliott & Kuhnen, Camelia & Winkielman, Piotr, 2008. "Nucleus accumbens activation mediates the influence of reward cues on financial risk-taking," MPRA Paper 8013, University Library of Munich, Germany.
  9. Rachel Croson & Uri Gneezy, 2009. "Gender Differences in Preferences," Journal of Economic Literature, American Economic Association, vol. 47(2), pages 448-74, June.
  10. Heaton, John & Lucas, Deborah, 2000. "Portfolio Choice in the Presence of Background Risk," Economic Journal, Royal Economic Society, vol. 110(460), pages 1-26, January.
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Cited by:
  1. Goedde-Menke, Michael & Langer, Thomas & Pfingsten, Andreas, 2014. "Impact of the financial crisis on bank run risk – Danger of the days after," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 522-533.
  2. Tim Friehe & Hannah Schildberg-Hörisch, 2014. "Crime and Self-Control Revisited: Disentangling the Effect of Self-Control on Risk and Social Preferences," CESifo Working Paper Series 4747, CESifo Group Munich.
  3. Francesco Zanetti, 2014. "Housing and Relative Risk Aversion," Economics Series Working Papers 693, University of Oxford, Department of Economics.
  4. Bruno Giovannetti & Mauro Rodrigues, Eduardo Ros, 2014. "Investment Grade, Asset Prices and Changes in the Source of Systematic Risk," Working Papers, Department of Economics 2014_05, University of São Paulo (FEA-USP).
  5. Eric T. Swanson, 2013. "Implications of labor market frictions for risk aversion and risk premia," Working Paper Series 2013-30, Federal Reserve Bank of San Francisco.
  6. Ampudia, Miguel & Ehrmann, Michael, 2014. "Macroeconomic experiences and risk taking of euro area households," Working Paper Series 1652, European Central Bank.

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