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Anxiety in the face of risk

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  • Eisenbach, Thomas M.

    (Federal Reserve Bank of New York)

  • Schmalz, Martin C.

Abstract

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.

Suggested Citation

  • Eisenbach, Thomas M. & Schmalz, Martin C., 2013. "Anxiety in the face of risk," Staff Reports 610, Federal Reserve Bank of New York, revised 01 Dec 2015.
  • Handle: RePEc:fip:fednsr:610
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    Cited by:

    1. Giglio, Stefano & Maggiori, Matteo & Stroebel, Johannes, 2014. "Very long-run discount rates," Globalization and Monetary Policy Institute Working Paper 182, Federal Reserve Bank of Dallas.
    2. Eisenbach, Thomas M. & Schmalz, Martin C., 2015. "Anxiety, overconfidence, and excessive risk-taking," Staff Reports 711, Federal Reserve Bank of New York, revised 01 Dec 2015.
    3. Koijen, Ralph & van Binsbergen, Jules H., 2015. "The Term Structure of Returns: Facts and Theory," CEPR Discussion Papers 10633, C.E.P.R. Discussion Papers.
    4. Andries, Marianne & Eisenbach, Thomas M. & Schmalz, Martin C., 2014. "Horizon-dependent risk aversion and the timing and pricing of uncertainty," Staff Reports 703, Federal Reserve Bank of New York, revised 01 Mar 2018.

    More about this item

    Keywords

    risk premia; insurance; term structure; dynamic inconsistency;

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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