Ephemeral Experiences, Long Lived Impact: Disasters and Portfolio Choice

Abstract

We investigate whether individual experiences of natural disasters affect portfolio choice. Using data from the National Longitudinal Survey of Youth 1979 Cohort, we show that past disaster experiences which are fleeting and last less than five days on average, have an economically significant effect lowering an individual's risky asset market participation, and the share of risky assets in the portfolio. Results control for age, year effects and household demographics and most recent disasters trigger stronger effects. These effects are observed mainly for exposure to severe natural disasters and persist even after the individual relocates to a new geographic area, not vulnerable to disasters. Individuals who live in a disaster prone area do not display this behavior unless they experience a disaster first hand. We find that individuals become risk averse and have lower expectation of future returns (but not volatility of returns) after disaster experiences. A quantitative decomposition of the disaster effect on portfolio choice shows that 45% of the effect is due to change in expectations and 55% of the effect is due to changes in risk aversion. Our results are consistent with a view that even transient but salient life experiences can affect an individual's preferences and tastes in dynamically meaningful ways.