Description and experience: How experimental investors learn about booms and busts affects their financial risk taking

Abstract

A few years ago, the world experienced the most severe economic crisis since the Great Depression. According to the depression baby hypothesis, people who live through such macroeconomic shocks take less financial risk in their future lives (e.g., lower stock market participation). This hypothesis has previously been tested against survey data. Here, we tested it in a simulated experimental stock market (based on the Spanish stock index, IBEX-35), varying both the length of historical data available to participants (including or excluding a macroeconomic shock) and the mode of learning about macroeconomic events (through sequential experience or symbolic descriptions). Investors who learned about the market from personal experience took less financial risk than did those who learned from graphs, thus echoing the description–experience gap observed in risky choice. In a second experiment, we reversed the market, turning the crisis into a boom. The description–experience gap persisted, with investors who experienced the boom taking more risk than those who did not. The results of a third experiment suggest that the observed gap is not driven by a wealth effect, and modeling suggests that the description–experience gap is explained by the fact that participants who learn from experience are more risk averse after a negative shock. Our findings highlight the crucial role of the mode of learning for financial risk taking and, by extension, in the legally required provision of financial advice.