Decrease In Risk Aversion Research Articles

State intervention in land pricing and endogenous risk aversion

<p><big>This study explores the cause and effect of endogenous risk aversion in land pricing, where state intervention through taxation remains a general practice. Using a consumption-based asset pricing model incorporating taxation, it is shown that high taxation, due to the indexation effect, supporting land prices and reducing individuals' risk expectations, could lead to an endogenous decrease in risk aversion, which could result in market dysfunction because risk aversion plays a key role in the market mechanism. China, with its wholly state-owned land and the general use of land sales to cover financial deficits, is a typical case for empirical tests. The tests confirm that there, the rise in land prices was driven by the increase in reserve prices set by local governments, a strong means of taxation, and not by the market, indicating the endogenous decrease in risk aversion.</big></p>

Overtime risk preference and its determinants: Evidence from Indonesia

<p>This research aims at examining the potential determinants of overtime risk preference in Indonesia–one of the most diverse countries in the world. We used household and individual data as well, taken from the fourth and fifth wave of the Indonesia Family Life Survey (IFLS). The risk aversion of the individual was observed and elicited using hypothetical gambling questions. From the result of Ordinary Least Square (OLS) estimation, we find preliminary evidence that there is a decrease in risk-aversion among individuals over time. However, there is little evidence that catastrophe will alter risk choice as a proxy for a significant life event. Furthermore, our empirical finding also revealed that risk tolerance is motivated not only by demographic factors but also by the education level and individual’s time preference.</p><p> </p><p> </p><div id="gtx-anchor" style="position: absolute; visibility: hidden; left: 278px; top: 80px; width: 27px; height: 12px;"> </div><div class="jfk-bubble gtx-bubble" style="visibility: visible; left: -131px; top: 102px; opacity: 1;"> </div><div id="gtx-anchor" style="position: absolute; visibility: hidden; left: 278px; top: 80px; width: 27px; height: 12px;"> </div><div class="jfk-bubble gtx-bubble" style="visibility: visible; left: -131px; top: 102px; opacity: 1;"> </div>

Wealth Fluctuations and Risk Preferences: Evidence from U.S. Investor Portfolios

Using data on the portfolio holdings and income of millions of U.S. retirement investors, I find that positive and persistent shocks to income lead to a significant increase in the equity share of investor portfolios, while increases in financial wealth due to realized returns lead to a small decline in the equity share. In a standard homothetic life-cycle model with human capital and constant risk aversion, the portfolio responses to these two wealth shocks should be of equal magnitude and opposite sign. The positive net effect in the data is evidence for risk aversion that decreases in total wealth. I estimate a structural life-cycle consumption and portfolio choice model that accounts for inertia in portfolio rebalancing and matches the reduced-form estimates with a significant degree of non-homotheticity in risk preferences, such that a 10% permanent income growth leads to an average decrease in risk aversion by 1.7%. Decreasing relative risk aversion preferences concentrate equity in the hands of the wealthy and double the share of wealth at the top of the wealth distribution.

Asset Prices and Liquidity with Market Power and Non-Gaussian Payoffs

We consider an economy populated by CARA investors who trade, accounting for their price impact, multiple risky assets with arbitrary distributed payoffs. We propose a constructive solution method: finding the equilibrium reduces to solving a linear ordinary differential equation. With market power and non-Gaussian payoffs: (i) the equilibrium is nonlinear and the model can speak to key stylized facts regarding asymmetry and nonlinearity of price response to order imbalances, (ii) when risk aversion decreases, there are more liquidity providers and/or there is less uncertainty about future asset payoffs, liquidity can decrease, (iii) cross-section of returns is affected by endogenous illiquidity.

A Quantitative Analysis of Risk Premia in the Corporate Bond Market

Measures of corporate credit risk incorporate compensation for unpredictable future changes in the credit environment and compensation for expected default losses. Since the launch of purchases of government securities and corporate securities by the European Central Bank, it has been discussed whether the observed reduction in corporate credit risk was due to the decrease in risk aversion favored by the monetary easing or by expectations of lower losses due to corporate defaults. This work introduces a new methodology to break down the factors that drive corporate credit risk, namely the premium linked to cyclical and monetary conditions and that linked to the restructuring of the companies. Untangling these two components makes it possible to quantify the drivers of excess returns in the corporate bond market.

Impact of Emergency Order in Price-Dependent Newsvendor Problems

This paper investigates the impact of emergency order in a price-dependent newsvendor setting. To this end, we compare two ways handling the excess demand: the excess demand is lost and a penalty cost is incurred, or the excess demand can be satisfied by an emergency order. Which way is better depends on the emergency purchase cost [Formula: see text] in emergency-order way and the price [Formula: see text] plus penalty cost [Formula: see text] in lost-sales way. For a risk-neutral newsvendor, our results indicate that, when [Formula: see text] is not larger than [Formula: see text], the emergency order way can lead to smaller order quantity and higher expected profit. We continue to discuss the impact of newsvendor’s risk aversion and demand uncertainty on the optimal decisions of the two ways. Theoretical analysis and numerical examples indicate that when the emergency purchase cost is not high, the differentials of the optimal order quantities and expected profits will be larger as the degree of risk aversion/demand uncertainty increases. What is more, we prove that there exists a threshold value of the emergency purchase cost so that the two ways handling excess demand can obtain the same expected profit, and this threshold value increases as the degree of risk aversion decreases.

The Pricing Strategy of Oligopolistic Competition Food Firms with the Asymmetric Information and Scientific Uncertainty

The arguments for and against genetically modified (GM) food focus on the characteristics of the scientific uncertainty and asymmetric information for the GM food. How do these two factors affect the competition and pricing strategy of food firms that separate GM food and conventional food conforming to consumer’s right to know? We explore the issue of pricing strategies between two firms producing horizontally and vertically differentiated foods in the context of asymmetric information and scientific uncertainty. The theoretical results show that there are two separating perfect Bayesian equilibria in which the prices of the conventional food and GM food are strategic complements and the profits of two types of firms are both increasing in the price of GM food. The numerical example shows that a decrease of the expected potential net damage as the most sensitive parameter leads to an increase of the profits of the two firms. Additionally, an increase in product differentiation helps to increase the two firms’ profits. Finally, the decrease in risk aversion as the second sensitive parameter helps to increase both products’ prices and quantities and both firms’ profits. This paper contributes by combining food safety regulation with market mechanisms and competition.

Risk Aversion and Engagement in the Sharing Economy

The sharing economy is a new online community that has important implications for offline behavior. This study evaluates whether engagement in the sharing economy is associated with an actor’s aversion to risk. Using a web-based survey and a field experiment, we apply an adaptation of Holt and Laury’s (2002) risk lottery game to a representative sample of sharing economy participants. We find that frequency of activity in the sharing economy predicts risk aversion, but only in interaction with satisfaction. While greater satisfaction with sharing economy websites is associated with a decrease in risk aversion, greater frequency of usage is associated with greater risk aversion. This analysis shows the limitations of a static perspective on how risk attitudes relate to participation in the sharing economy.

On the risk-averse procurement strategy under unreliable supply

This study investigates an effective procurement/inventory strategy for a risk-averse retailer facing unreliable supply and stochastic demand. By using an increasing and concave utility function to describe risk aversion, we construct a basic newsvendor (single-period) model and its multi-period extension. Both models are found to have unique solutions, as the optimized expected utility is strictly concave in initial inventory level. As a result, there is a unique optimal order quantity for the effective control of supply risk. For the single-period model, the optimal order quantity is derived in its analytical form. We then show by numerical analysis that the value of the optimized expected utility is a function of the initial inventory level when the retailer is risk-averse, becomes less sensitive to initial inventory level when the degree of risk aversion decreases, and is insensitive for the risk-neutral case. This finding suggests that in our setting the inventory holding matters only when the retailer is risk-averse. For the multi-period model, we propose a solution procedure using backward induction since a direct extension of the single-period solution is impossible. We also conduct a sensitivity analysis of demand and supply with the aim of giving some managerial suggestions for demand risk control and supplier selection.

Risk taking by agents: The role of ex-ante and ex-post accountability

We study the role of accountability in situations where an agent makes risky decisions for a principal. We observe that in the absence of accountability, agents choose less risk averse investments for the principal than investors who invest for their own account. Accountability mitigates the observed decrease in risk aversion. Differences are observed between situations where agents are accountable for their decision (“ex-ante”) and where they are accountable for the outcome (“ex-post”).

Liability-Driven Investment with DownsideRisk

The authors develop a liability-driven investment framework that incorporates downside risk penalties for not meeting liabilities. The shortfall between the asset and liabilities can be valued as an option that swaps the value of the endogenously determined optimal portfolio for the value of the liabilities. The optimal portfolio selection exhibits endogenous risk aversion and, as the funding ratio deviates from the fully funded case in both directions, effective risk aversion decreases. When funding is low, the manager swings for the fences to take on risk, betting on the chance that liabilities can be covered. Over-funded plans also can afford to take on more risk, as liabilities are already well covered and so invest aggressively in risky securities.

Measuring risk aversion with lists: a new bias

Various experimental procedures aimed at measuring individual risk aversion involve a list of pairs of alternative prospects. We first study the widely used method by Holt and Laury (Am Econ Rev 92(5):1644–1655, 2002), for which we find that the removal of some items from the lists yields a systematic decrease in risk aversion and scrambles the ranking of individuals by risk aversion. This bias, that we call embedding bias, is quite distinct from other confounds that have been previously observed in the use of the HL method. It may be related to empirical phenomena and theoretical developments where better prospects increase risk aversion. Nevertheless, we also find that the more recent elicitation method due to Abdellaoui et al. (Theory Decis 71:63–80, 2011), also based on lists but using only one and the same probability in the list, does not display any statistically significant bias when the corresponding items of the list are removed. Our results suggest that methods other than the popular HL one may be preferable for the measurement of risk aversion.

Liability Driven Investment with Downside Risk

We develop a liability driven investment framework that incorporates downside risk penalties for not meeting liabilities. The shortfall between the asset and liabilities can be valued as an option which swaps the value of the endogenously determined optimal portfolio for the value of the liabilities. The optimal portfolio selection exhibits endogenous risk aversion and as the funding ratio deviates from the fully funded case in both directions, effective risk aversion decreases. When funding is low, the manager 'swings for the fences' to take on risk, betting on the chance that liabilities can be covered. Over-funded plans also can afford to take on more risk as liabilities are already well covered and so invest aggressively in risky securities.

TIME VARIABILITY IN MARKET RISK AVERSION

AbstractWe adopt realized covariances to estimate the coefficient of risk aversion across portfolios and through time. Our approach yields second moments that are free from measurement error and not influenced by a specified model for expected returns. Supporting the permanent income hypothesis, we find risk aversion responds to consumption‐smoothing behavior. As income increases, or as the consumption‐to‐income ratio falls, relative risk aversion decreases. We also document variation in risk aversion across portfolios: risk aversion is highest for small and value portfolios.

Does risk aversion accelerate optimal forest rotation under uncertainty?

We use a Wicksellian single rotation framework to analyze the impact of a stochastic mean-reverting interest rate process on the optimal harvesting threshold and thereby the expected length of the rotation period, when the forest stand value follows a geometric Brownian motion and landowners are risk-averse. We solve explicitly the two-dimensional path-dependent rotation problem and demonstrate that higher interest rate volatility increases, while higher risk aversion decreases, the optimal harvesting threshold. Under risk aversion higher forest value volatility decreases the optimal harvesting threshold, while it has no effect under risk neutrality. Numerical illustrations indicate that higher interest rate volatility will raise the expected rotation period at an increasing rate, while higher forest value volatility will decrease its sensitivity under risk aversion.

Saving and investing for early retirement: A theoretical analysis

We study optimal consumption and portfolio choice in a framework where investors adjust their labor supply through an irreversible choice of their retirement time. We show that investing for early retirement tends to increase savings and reduce an agent's effective relative risk aversion, thus increasing her stock market exposure. Contrary to common intuition, an investor might find it optimal to increase the proportion of financial wealth held in stocks as she ages and accumulates assets, even when her income and the investment opportunity set are constant. The model predicts a decrease in risk aversion following strong market gains like those observed in the nineties.

Optimal portfolio delegation when parties have different coefficients of risk aversion

We consider the problem of delegated portfolio management when the involved parties are risk-averse. The agent invests the principal's money in the financial market, and in return he receives a compensation which depends on the value that he generates over some period of time. We use a dual approach to explicitly solve the agent's problem analytically and subsequently we use this solution to solve the principal's problem numerically. The interaction between the principal's and the agent's risk aversion and the optimal compensation scheme is studied and, for example, in the case of the more risk averse agent according to common folklore the principal should optimally choose a fee schedule such that the agent's derived risk aversion decreases. We illustrate that this is not always the case.

Sovereign Debt Contract and Optimal Consumption-Investment Strategies

We present a model in which a sovereign country optimally decides on its consumption and investment policies. In the paper we allow for the sovereign borrower to keep the fraction of his augmented wealth in so-called international reserves. We further assume that these reserves can be deposited at the risk-free rate. In this framework we obtain analytical solutions for optimal consumption and investment rules, as well as formulas for optimal default boundary and the value of the risky loan. In the paper we assume that in the case of default the lender can impose economic and political sanctions against the borrower and also can seize an implicit collateral. However, it is shown that only sanctions are necessary for the existence of positive lending equilibrium. We also show that when the country is getting very close to its default wealth level, then its relative risk aversion decreases and the country increases its consumption rate and the risky investment fraction at the expense of available liquid reserves.

Sovereign Debt Contract and Optimal Consumption-Investment Strategies

We present a model in which a sovereign country optimally decides on its consumption and investment policies as well as on the optimal time to default. In the paper we allow the sovereign borrower to keep the fraction of its augmented wealth in so-called international reserves. We further assume that these reserves can be deposited at the risk-free rate. In this framework, we obtain analytical solutions for optimal consumption and investment rules, as well as formulas for optimal default boundary and the value of the risky loan. In the paper we assume that in the case of default the lender can impose economic and political sanctions against the borrower and also can seize an implicit collateral. We show that when the country is getting very close to its default wealth level, then its relative risk aversion decreases and the country increases its consumption rate and the risky investment fraction at the expense of available liquid reserves.

Expected utility, ?-? preferences, and linear distribution classes: A further result

This article is an extension of Meyer and Sinn's results on the representation of arbitrary von Neumann-Morgenstern functions in μ-σ space when the probability distributions to be compared belong to a linear distribution class. It shows that, when absolute risk aversion decreases, stays constant, or increases not too fast, an increase in σ, given μ, increases the indifference curve slope: increased riskiness increases the required marginal compensation for risk when risk is measured by the standard deviation of wealth or income.