Abstract
We investigate how volatility shocks affect investors risk-taking, risk perception and forecasts. We run artefactual field experiments with two participant pools (finance professionals and students), differing in (i) the direction of the shock (down, up, or a neutral case) and (ii) the presentation format of the time series (prices or returns). Professionals investments are negatively associated with the price change and performance of the stock and their perceived risk increases to a similar extent following shocks of all directions. Students risk perception, in contrast, is more closely related to the frequency of negative returns rather than an increase in volatility.
Highlights
Nassim Nicolas Taleb (2007) famously coined the term “black swan” to describe rare and unpredictable outlier events, which have an extreme impact
We investigate how volatility shocks affect investors’ risk-taking, risk perception and forecasts
We presented results from a novel artefactual field experiment with 202 finance professionals and 282 students from economics and business to investigate participants’ reactions to volatility shocks, i.e., to a change in the underlying return distribution in an investment experiment with sequential price and return realizations
Summary
Nassim Nicolas Taleb (2007) famously coined the term “black swan” to describe rare and unpredictable outlier events, which have an extreme impact. Applied to financial markets, such tail events, such as a major crash, can wipe out years of accumulated returns and can influence people’s beliefs, perceptions, and behavior for a long time (e.g., Cogley & Sargent, 2008; Graham & Narasimhan, 2005; Guiso et al, 2018; Malmendier & Nagel, 2011). It is the big price surges and crashes that most vividly come to mind when thinking of financial markets; these events can have long-lasting effects on the outcome of an investment, as it may take years to make up a substantial loss, for instance. Second, return volatility (the standard deviation of returns) varies over time as “normal,” tranquil times are interrupted by high-volatility clusters (e.g., Andersen & Bollerslev, 1997; Alizadeh et al, 2002; Mandelbrot & Hudson, 2008): Negative tail events are often followed by positive tail events and together constitute periods of high volatility on financial markets.
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