Abstract
The risk attitude of investors is a key factor determining financial asset prices and market trends. Changes in risk attitude may be due to the interference of macro-level (business cycle) and micro-level (individual experience) effects. We investigate the impact of individual experience on the subsequent risk-taking attitude of professionals via the analysis of the trading activity of 351 non-financial firms and (non-bank) financial institutions (insurance companies, financial intermediaries, etc.) covering 57,039 FX forward transactions in a highly volatile period between January 2008 and November 2012. Panel regressions for all firms and institutions do not show significant behavioral patterns. When investigating each client separately, however, we find that 39.7% of the clients having enough transactions to analyze statistically tend to increase their risk exposure irrationally after large gains or losses which can be the manifestation of the break-even and house-money effects well-documented in the literature for non-professionals. This irrational behavior may destroy value, so both market players and regulators should pay attention to monitor and control it.
Highlights
Introduction and literature reviewThe risk attitude of economic players affects risk premia, investment decisions, and asset prices (Benchimol 2014)
This is consistent with CRRA utility functions, too, which are the most popular in economic literature (Arrow 1965; Mehra and Prescott 1985; Herings and Kubler 2007), implying that people keep a constant percentage of their portfolio in risky assets independently of their actual level of wealth
In rational models with a CRRA utility function, if the investor realizes a positive profit, his wealth increases, the percentage of risky assets remains constant, but the absolute value of the risky assets increases, so there is a positive relationship between previous profits and the subsequent absolute risk exposure. (We use the term „profit” as a signed number, a negative profit means a loss.)
Summary
Introduction and literature reviewThe risk attitude of economic players affects risk premia, investment decisions, and asset prices (Benchimol 2014). Our investment horizon is much longer than that of Post et al (2008) or Coval and Schumway (2005) who investigated intraday behavioral patterns, whereas we calculate profits and exposures on a monthly basis and run panel regression models with time and firm fixed effects.
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