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Anxiety in the face of risk

  • Eisenbach, Thomas M.

    (Federal Reserve Bank of New York)

  • Schmalz, Martin C.

We model an “anxious” agent as one who is more risk averse with respect to imminent risks than with respect to distant risks. Based on a utility function that captures individual subjects’ behavior in experiments, we provide a tractable theory relaxing the restriction of constant risk aversion across horizons and show that it generates rich implications. We first apply the model to insurance markets and explain the high premia for short-horizon insurance. Then, we show that costly delegated portfolio management, investment advice, and withdrawal fees emerge as endogenous features and strategies to cope with dynamic inconsistency in intratemporal risk-return tradeoffs.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 610.

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Length: 36 pages
Date of creation: 2013
Date of revision: 01 Dec 2015
Handle: RePEc:fip:fednsr:610
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