Increased Risk Aversion Research Articles

Cooperative game with nondeterministic returns

We study a non-traditional cooperative game where returns from coalitions are nondeterministic. The long-standing concept of core can be generalized to reflect players’ contentment with their allocations. It is now imperative to formalize the restrictions, such as those pertaining to information, on allocations. The latter are also at times more conducive to fractional representations. With probabilistic structures added, nondeterministic returns become random variables, utility functions attain risk-attitude connotations, and the timing of players’ allocation resolutions gains significance. Under various conditions for utility functions, we show how various core concepts of the general game can be related to its traditionally defined auxiliaries. These developments help pave the way for our illustrations, within two distinct settings, that players’ increased risk aversion would promote the formation of the grand coalition.

Recent Experiences and Risk Taking: Trading Responses to Changes in the Local Environment

We use data from a German online brokerage and a survey to show that retail investors sharply reduce risk-taking in response to nearby firm bankruptcies, which are not predictive of returns. The effects on trading are spatially highly concentrated, immediate and not persistent. They seem to operate through more pessimistic expected returns and increased risk aversion and do not reflect wealth effects or changes in background risks. Investors learn about bankruptcies through immediate coverage in local newspapers. Our findings suggest that non-informative local experiences that make downside risks of stock investment more salient contribute to idiosyncratic short-term fluctuations in trading.

Using a dependent schedule to measure risky choice in male rats: Effects of d-amphetamine, methylphenidate, and methamphetamine.

Risky choice is the tendency to choose a large, uncertain reward over a small, certain reward, and is typically measured with probability discounting, in which the probability of obtaining the large reinforcer decreases across blocks of trials. One caveat to traditional procedures is that independent schedules are used, in which subjects can show exclusive preference for one alternative relative to the other. For example, some rats show exclusive preference for the small, certain reinforcer as soon as delivery of the large reinforcer becomes probabilistic. Therefore, determining if a drug increases risk aversion (i.e., decreases responding for the probabilistic alternative) is difficult (due to floor effects). The overall goal of this experiment was to use a concurrent-chains procedure that incorporated a dependent schedule during the initial link, thus preventing animals from showing exclusive preference for one alternative relative to the other. To determine how pharmacological manipulations alter performance in this task, male Sprague-Dawley rats (n = 8) received injections of amphetamine (0, 0.25, 0.5, 1.0 mg/kg), methylphenidate (0, 0.3, 1.0, 3.0 mg/kg), and methamphetamine (0, 0.5, 1.0, 2.0 mg/kg). Amphetamine (0.25 mg/kg) and methylphenidate (3.0 mg/kg) selectively increased risky choice, whereas higher doses of amphetamine (0.5 and 1.0 kg/mg) and each dose of methamphetamine impaired stimulus control (i.e., flattened the discounting function). These results show that dependent schedules can be used to measure risk-taking behavior and that psychostimulants promote suboptimal choice when this schedule is used. (PsycInfo Database Record (c) 2020 APA, all rights reserved).

Balancing the desire for privacy against the desire to hedge risk

Abstract An individual's desire to hedge risks, as implied by risk aversion, is accepted as a normative paradigm and documented as valid descriptively. Insurance markets satisfy this desire, wherein the individual's aversion to bear risk allows firms to demand a markup on the expected value of the insured loss. Insurance firms incrementally introduce digital monitoring technology into their policies, making policyholder's behavior transparent. We analyze the implications of such transparency insurance contracts for willingness to pay in a framed behavioral experiment and find that the loss of privacy in such contracts marginalizes the potential profits that insurers could earn on their policies. In particular, our results suggest that the reduction in willingness to pay from introducing digital monitoring is in the range of 25–50% of the expected loss. While an absolute as opposed to a relative monetary valuation concept of privacy appears more likely to explain our data, we cannot clearly confirm this conjecture empirically. Heterogeneous treatment effects for risk preferences are suggestive for increasing utility losses from transparency policies with increasing risk aversion but we also observe indications of nonlinearities in this relationship. Probability misperception is a salient characteristic of our experimental population, suggesting that profitability is less threatened under low-frequency risks as opposed to high-frequency risks.

Analyzing corn and cotton producers optimal prevented planting decision on moral hazard

AbstractThe prevented planting provision U.S. crop insurance programs protects producers from financial losses and risk associated with delayed planting. This provision has recently undergone some changes due to concerns about moral hazard in this provision. However, little is known about the likelihood of moral hazard in prevented planting and how these changes impact this possibility. We compared the net returns and variability of net returns for the four prevented planting options available for a corn (Zea mays L.) and upland cotton (Gossypium hirsutum L.) producer assuming soybean [Glycine max (L.) Merr.] as a viable second crop. We determine the optimal prevented planting option using the current prevented planting coverage factor at three crop insurance coverage levels. We also show how reductions in the prevented planting coverage factor would change the optimal selection and moral hazard in prevented planting. Data were collected from non‐irrigated corn, upland cotton, and soybean planting date experiments located in Tennessee. Yield response functions to planting date for corn, cotton, and soybean were estimated and incorporated into simulation models to generate distributions of net returns. Risk neutral, profit maximizers would choose a late planting option over the full prevented planting payment, but as risk aversion increases, the full prevented planting payment was preferred. Reduction in prevented planting coverage factors will likely reduce the likelihood an insured producer chooses to not produce a crop and take the full prevented planting indemnity payment, despite planting during the late planting period or switching crops being more profitable options.

Portfolio Liquidation under Factor Uncertainty

We study an optimal liquidation problem under the ambiguity with respect to price impact parameters. Our main results show that the value function and the optimal trading strategy can be characterized by the solution to a semi-linear PDE with superlinear gradient, monotone generator and singular terminal value. We also establish an asymptotic analysis of the robust model for small amount of uncertainty and analyse the effect of robustness on optimal trading strategies and liquidation costs. In particular, in our model ambiguity aversion is observationally equivalent to increased risk aversion. This suggests that ambiguity aversion increases liquidation rates.

Are pesticides risk decreasing? The relevance of pesticide indicator choice in empirical analysis

AbstractThe reduction of adverse health and environmental effects from pesticide use is currently a top priority on the agricultural policy agenda. Efficient pesticide policies must take into account farmers’ application behavior, especially effects of pesticide use on economic risk. However, previous results regarding the direction of risk effects of pesticides are ambiguous. We show that the ambiguity in earlier studies could be due to the pesticide indicator selected. Indicators which fail to account for the heterogeneous properties of pesticides may be inapt for interpreting farmers’ pesticide use decisions. Our analysis, based on a rich panel dataset of Swiss wheat producers with highly detailed information on pesticide use, considers different pesticide indicators and multiple sources of uncertainty. Our key finding is that indicator choice affects the magnitude and sign of estimated risk effects. Estimates of pesticide productivity and risk effects are significantly higher for fungicides, and even reversed for herbicides when we measure pesticide use in simple quantity units (kilogram per hectare) ‐ compared to the quality and intensity corrected Load Index. This means for example, that farmers will ceteris paribus use lower quantities of herbicides, but will increase the overall toxicity of the products applied with increasing risk aversion. We discuss implications of our findings for the design of pesticide policies and agricultural risk management instruments.

Terrorist attacks and investor risk preference: Evidence from mutual fund flows

Using a comprehensive list of terrorist attacks over three decades, we find that aggregate investor risk aversion inversely relates to terrorist activity in the United States. A one standard deviation increase in the number of attacks each month leads to a $75.09 million drop in aggregate flows to equity funds and a $56.81 million increase to government bond funds. Tests on alternative channels further suggest that the shift in aggregate risk aversion is driven mainly by an emotional shock rather than changes in wealth or the outside environment. We also investigate possible alternate explanations for reduced flows to risky assets. Our evidence is consistent with a fear-induced increase in aggregate risk aversion.

Risk Preferences and Economic Shocks: Experimental Evidence

We demonstrate in our experiment that an exogenous shock does not lead to increasing risk aversion, and has ultimately no significant impact on investors’ risk preference in general. To do so, we keep subjects’ risk and return expectations fixed and focus solely on loss in wealth. As a theoretical framework, we use the expected utility approach and take the class of HARA-utility functions to analyse subjects’ preferences. Particularly, our methodical approach affords insights into the impact of economic fluctuations on investors’ risk-taking and the measurement of risk preferences per se. We conclude that cautious investment behavior after an economic crisis might rather be due to changes in the perception of risk and return. Moreover, we give evidence that, in general, it is not sufficient to explain investors’ risk-taking solely by preferences.

The Optimal Decisions for Formation International Joint Ventures under Uncertainty

This paper develops a model in which the two parties to an international joint venture (IJV) determine the optimal cost ratio and profit share and exercise the jointly held option to enter into an IJV in uncertain situations. In our setting, the two partners make their decisions sequentially under a two-stage Stackelberg game framework, where the risk-neutral multinational company as the leader first designs the cost and equity allocation, and then the risk-averse local firm follows by choosing the optimal timing at which to exercise the joint venture option. The Stackelberg equilibrium solutions to the model are obtained by using a mix of game theory and real options. The results of the numerical analysis show that despite the multinational company's dominant position in the IJV, its equity share is not always higher than that of the local company and is closely related to the expected growth rate, risk aversion level and market volatility. The cost ratio of the foreign partner will increase correspondingly with its equity ratio unless it faces much more uncertainty in the environment. In addition, an increase in risk aversion leads to the local company sharing a higher proportion of the equity and costs of the joint venture partnership. The findings of the study can provide scientific guidance and suggestions on the transnational joint venture for overseas investment, especially in the “One Belt and One Road” initiative.

The Trading Response of Individual Investors to Local Bankruptcies

We use data from a German online brokerage and a survey to show that retail investors sharply reduce risk-taking in response to nearby firm bankruptcies, which are not predictive of returns. The effects on trading are spatially highly concentrated, immediate and not persistent. They seem to operate through more pessimistic expected returns and increased risk aversion and do not reflect wealth effects or changes in background risks. Investors learn about bankruptcies through immediate coverage in local newspapers. Our findings suggest that non-informative local experiences that make downside risks of stock investment more salient contribute to idiosyncratic short-term fluctuations in trading.

The Effect of a Major Pandemic on Risk Preferences - Evidence from Exposure to COVID-19

The present paper studies the effect of the COVID-19 pandemic on risk preferences. Using real-time panel data from the year before the pandemic and from the first few months of the pandemic in Germany (April to July 2020), we provide robust evidence that exposure to COVID-19 reduces individual risk tolerance. We establish a causal link between the pandemic and risk tolerance by exploiting longitudinal and regional variation in infection rates. Our analysis shows that increased risk aversion can be observed in particular among better educated and more affluent respondents.We further provide suggestive evidence that economic concerns, health concerns, and self-reported health partially mediate the relationship of interest.

COVID-19’s Reality Shock for External-Funding Dependent Emerging Economies

COVID-19 has brought to light a reality that had been mostly forgotten in an era of ample dollar liquidity: the excessive dependence of emerging economies on external financing. The sudden increase in global risk aversion arising from COVID-19 has caused investors to rush to safe assets and to the dollar, away from no-reserve currencies. The COVID-19 shock has also sharply reduced emerging markets’ access to dollars, exports, tourism receipts and even remittances, as the shock also affects the countries where migrants earn their incomes. The fiscal and monetary room emerging economies have to respond is limited, and the lack of automatic stabilisers on the fiscal side also means that fiscal policy does not have the same redistributive effects during a severe shock as in the developed world. In principle, various options are available to confront liquidity problems: domestic monetary policy, capital controls, dipping into foreign exchange reserves, regional schemes such as the Chiang Mai Initiative Multilateralisation, central bank swap lines, and International Monetary Fund programmes. But not all these options are available to most countries. Central banks’ responses to the pandemic have been much less aggressive in the emerging world than in the west, as their currencies have plummeted in many cases, increasing the cost of dollar liabilities. Capital controls are temporary and costly. Self-insurance and regional insurance schemes are unavailable to many economies, particularly in Latin America. The United States Federal Reserve has reacted quickly with swap lines to key central banks, but this is only a partial option because the Fed risks being overburdened in its attempt to provide cross-border dollar liquidity. The IMF remains the most obvious lender of last resort for emerging economies, but needs to make two changes to become more effective: a more targeted set of facilities with quicker disbursement and less conditionality; and increased financial resources.

Investors’ behavior and mutual fund portfolio allocations in Brazil during the global financial crisis

In this paper, I examine the flow and performance of mutual funds in Brazil and their portfolio allocations during the global financial crisis. First, I show that mutual funds exposed to deposits and securities issued by small banks suffered significant outflows, due to the increased risk aversion following Lehman’s default in 2008. The returns of funds exposed to small banks were also negatively affected. Funds adjusted their portfolios by reducing their exposures to deposits of small banks, but they increased risk taking when term deposit coverage limits were raised. The distress among small banks also generated negative spillover to the portfolio management business of banks, reducing their numbers of investors. The results illustrate the potential risks to financial stability, to the extent that interconnections among funds and banks can induce the transmission of shocks across markets.

A shrinking horizon optimal liquidation framework with lower partial moments criteria

In this paper, a novel quasi-multiperiod model for optimal position liquidation in the presence of both temporary and permanent market impact is proposed. Two main features distinguish the proposed approach from its alternatives. First, a shrinking horizon framework is implemented to update intraday parameters by incorporating new incoming information while maintaining standard nonanticipativity constraints. The method is data-driven, numerically tractable and reactive to the market. Second, lower partial moments, a downside risk measure, is used. Unlike symmetric measures, such as variance, this captures traders’ increased risk aversion to losses. The performance of the proposed strategies is tested using historical, high-frequency New York Stock Exchange data. All proposed strategies outperform classic strategies such as a time-weighted average price strategy as well as more unrealistic strategies such as an ex-post volume-weighted average price strategy that violates nonantici- pativity on days with unfavorable market conditions; this strongly supports the use of lower partial moments as a risk measure. In addition, the papers results validate the use of a shrinking horizon framework as an adaptive, tractable alternative to dynamic programming for trading.

Forecasting Realized Stock-Market Volatility: Do Industry Returns Have Predictive Value?

Yes, they do. Utilizing a machine-learning technique known as random forests to compute forecasts of realized (good and bad) stock market volatility, we show that incorporating the information in lagged industry returns can help improve out-of sample forecasts of aggregate stock market volatility. While the predictive contribution of industry level returns is not constant over time, industrials and materials play a dominant predictive role during the aftermath of the 2008 global financial crisis, highlighting the informational value of real economic activity on stock market volatility dynamics. Finally, we show that incorporating lagged industry returns in aggregate level volatility forecasts benefits forecasters who are particularly concerned about under-predicting market volatility, yielding greater economic benefits for forecasters as the degree of risk aversion increases.

Sensitivity to gains during risky decision-making differentiates chronic cocaine users from stimulant-naïve controls

BackgroundChronic cocaine use has been consistently associated with decision-making impairments that contribute to the development and maintenance of drug-taking. However, the underlying cognitive processes of risk-seeking behaviours observed in chronic cocaine users (CU) have so far remained unclear. Here we therefore tested whether CU differ from stimulant-naïve controls in their sensitivity to gain, loss, and probability of loss information when making decisions under risk. MethodA sample of 96 participants (56 CU and 40 controls) performed the no-feedback version of the Columbia Card Task, designed to assess risk-taking in relation to gain, loss, and probability of loss information. Additionally, cognitive performance and impulsivity were determined. Current and recent substance use was objectively assessed by toxicological urine and hair analysis. ResultsCompared to controls, CU showed increased risk-seeking in unfavourable decision scenarios in which the loss probability was high and the returns were low, and a tendency for increased risk aversion in more favourable decision scenarios. In comparison to controls, CU were less sensitive to gain, but similarly sensitive to loss and probability of loss information. Further analysis revealed that individual differences in sensitivity to loss and probability of loss information were related to cognitive performance and impulsivity. ConclusionReduced sensitivity to gains in people with CU may contribute to their propensity for making risky decisions. While these alterations in gain sensitivity might directly relate to cocaine use per se, the individual psychopathological profile of CU might moderate sensitivity to loss information.

Participation patterns of the rainfall index insurance for pasture, rangeland and forage programme

Using a novel policyholder-level data set, we analyse participants’ choices of 2-month index intervals in the Rainfall Index for Pasture, Rangeland and Forage (RI-PRF) insurance programme. We first provide a conceptual model that illustrates participation patterns of the rainfall index insurance. We then connect these predicted patterns to some empirical evidence from the policyholder-level data set, which is a subset of data provided by the USDA Risk Management Agency for all RI-PRF participants in Nebraska and Kansas during the years 2013–2017. Because the correlations between forage yield and precipitation and the expected premium subsidy vary by month, different degrees of risk aversion may predict distinctively different choices of the 2-month intervals. Using cluster analysis, we group the participants with similar allocation patterns across the 2-month intervals. We observe that the number of participants displaying relatively low levels of risk aversion increase over time. We connect this to the fact that premium subsidies and producer returns associated with non-growing season (risk-increasing) months are often greater than those for growing season (risk-reducing) months, and this has important implications for policy design. Our findings suggest that more research in this area could assist policymakers in keeping the RI-PRF programme in line with its objective of reducing risk for livestock producers.

Exposure to Transit Migration, Public Attitudes, and Entrepreneurship among the Native Population

We study the impact of the recent migration crisis on entrepreneurship in transit countries using a unique locality-level panel from the 2010 and 2016 rounds of the Life in Transition Survey for 18 European countries. To capture the exogenous variation in exposure to transit migration, we construct an instrument that exploits the distance of each locality to the optimal routes that minimise travelling time between the main origin and destination countries. We find that the entrepreneurial activity of natives falls considerably in localities that are more exposed to mass migration, compared to those located further away. We rule out mechanisms related to the outmigration of the local population and changes in local labour market conditions. Instead, our analysis suggests that increases in risk aversion and perceived political instability, accompanied by a decrease in governmental trust are the main mechanisms explaining the fall in entrepreneurial activity. Consistent with these results, we also document an increase in the anti-migrant sentiment while attitudes towards other population groups remained unchanged.

How do product quality uncertainties affect the sharing economy platforms with risk considerations? A mean-variance analysis

The sharing economy is of increasing importance for various aspects of our society by providing people with cost-efficient and convenient access to services or products. However, the profitability and healthy development of the sharing economy platforms are greatly restricted by the intensive uncertainties arising from product quality. How to determine the optimal product quality improvement efforts and the optimal prices for the sharing platforms becomes crucial. Moreover, it is reasonable that many sharing economy platforms and consumers are holding a risk-averse attitude during decision making in the highly volatile market. In this paper, we employ the Mean-Variance theory to model the risk-averse attitudes of decision makers, and analytically derive the optimal average quality levels and prices that the platform should provide for the market. We also explore how the critical factors like product quality uncertainty and risk sensitivity affect the platform's equilibrium decisions and consumer surplus. Our analytical results reveal the importance of reducing the difficulty of improving product quality for enhancing the platforms' profitability and consumer surplus. Besides, we identify that it is not always wise for platforms to invest in improving product quality, especially when the related cost becomes increasingly expensive. Moreover, it is shown that the increasing risk aversion or product quality volatility will induce the platform to reduce his quality improvement efforts. Finally, we interestingly find that the platform will always suffer if he becomes risk averse from risk neutral, while consumers may benefit from this attitude change.