Risk Tolerant Investors Research Articles

Crude credit: The political economy of natural resource booms and sovereign debt management

Oil, gas, and minerals have notoriously adverse effects on institutional quality. But when global liquidity is high, risk-tolerant investors are more willing to lend to all borrowers, even resource-rich countries with low-quality institutions. Despite the availability of cheaper credit during commodity booms, we argue that countries do not increase current borrowing to mitigate future revenue shortfalls during commodity busts. Instead, they rely on resource windfalls to meet their current financing needs, fearing they would otherwise forfeit national policy discretion to global financial markets. We leverage primary evidence from extensive field research across five Latin American countries to show that national economic officials (i.e. finance ministers and central bank governors) are wary of high indebtedness, after past commodity booms ended in cycles of lofty spending, borrowing, and default. For sovereign borrowers, high bond market indebtedness often reduces government discretion over economic policy, whereas windfalls increase it; all else equal, governments will favor the latter. Using data on 22 Latin American and Caribbean countries from 1996 to 2020, we find that governments issue bonds less frequently, in smaller amounts, as their oil and gas production or GDP share from resource rents increases. These findings make an important contribution to our understanding of how commodity cycles affect global capital markets: sovereign borrowers do not fully leverage commodity booms to expand their fiscal space to finance more spending over time.

An Empirical Assessment of Characteristics and Optimal Portfolios

Abstract We implement a dynamically regularized, bootstrapped two-stage out-of-sample parametric portfolio policy to evaluate characteristics’ efficacy in the conditional stock return-generating process in the metric of expected power utility. Traditional characteristics, such as momentum and size afforded large utility gains before 1999. These opportunities have since vanished. Overfitting—imprecision in weight estimation—is correlated with the optimal portfolio’s variance. Therefore, it is not a problem for power utility investors with coefficients of relative aversion greater than four. For more risk-tolerant investors, we successfully reduce estimation error by increasing the curvature of the loss function relative to the investor’s utility function. (JEL L200; C110; C350)

Prior perceived losses and investment objectives after stock market crisis: a moderated-mediation model of risk tolerance and loss aversion.

This study explores whether prior perceived losses affect investment objectives via loss aversion as a mediator and whether the indirect effect is moderated by risk tolerance in a moderated-mediation model. Using retail investors who witnessed a market crash in Bangladesh and experienced losses, the model is tested by employing regression analyses and conditional process. The analyses reveal that prior perceived losses indirectly affect investment objectives (earning a higher expected return and building a financial reserve for future expenses) via mediation of loss aversion. Moderated-mediation model shows that for high-risk-tolerant investors, prior perceived losses indirectly affect investors to invest more for achieving a higher expected return objective and less to achieving building a financial reserve for future expenses, via a low level of loss aversion. These suggest that risk-tolerant investors continue to invest to earn a higher expected return even though they experienced prior losses and are loss-averse. Supplementary InformationThe online version contains supplementary material available at 10.1007/s43546-022-00259-6.

Risky Asset Holdings During Covid-19 and their Distributional Impact: Evidence from Germany.

We present evidence from a repeated survey on risky asset holdings carried out on a representative sample of the German population six times between April and June 2020. Given the size of the Covid‐19 shock, we find little evidence of portfolio rebalancing in April 2020. In May, however, individual investors started buying heavily, parallel to market recovery. The cross‐section shows large differences as young, educated, high income, and risk tolerant investors are net buyers throughout and, thus, benefit from the stock market recovery. Older individuals, parents of young children, and individuals affected by adverse liquidity shocks from Covid‐19 are net sellers. Given the high risk of illness, older people are hit by dual blows to both health and finances.

Risky Asset Holdings during Covid-19 and Their Distributional Impact: Evidence from Germany

We present evidence from a repeated survey on risky asset holdings carried out on a representative sample of the German population six times between April and June 2020. Given the size of the Covid-19 shock, we find little evidence of portfolio rebalancing in April 2020. In May, however, individual investors started buying heavily, fueling market recovery. The cross-section shows large differences as young, educated, high income, and risk tolerant investors are net buyers throughout and, thus, benefit from the stock market recovery. Older individuals, parents of young children, and individuals affected by adverse liquidity shocks from Covid-19 are net sellers. Given the high risk of illness, older people are hit by dual blows to both health and finances.

The Tracking Efficiency of Physical and Synthetic Equity Index ETFs

This article evaluates the tracking efficiency of physical and synthetic Exchange Traded Funds (ETFs). Theoretically, synthetic ETFs should provide greater tracking efficiency. We study this using ETFs domiciled in Europe tracking the European, United States and Emerging Markets. We calculate the tracking error differences and use univariate analysis across both replication and regional strategies. Our contribution is in identifying the variables that influence ETF tracking efficiency. We find the total expense ratio remains the pre-eminent explanatory variable, but the type of replication strategy is a significant secondary factor. We observe that the counterparty risk in synthetic strategies is not rewarded relative to physical replication strategies, but the synthetic ETFs increase returns of tangency portfolios compared to physical ETFs when analyzed using mean-variance spanning techniques. This suggests investment in synthetic strategies is suited to risk tolerant investors and investment in physical strategies is more suited for risk averse investors. TOPICS:Exchange-traded funds and applications, analysis of individual factors/risk premia, VAR and use of alternative risk measures of trading risk, risk management, interest-rate and currency swaps Key Findings • The type of replication strategy employed by an ETF is a significant secondary factor in its tracking efficiency. • Synthetic ETFs’ replication increases returns of tangency portfolios compared to physical ETFs when analyzed using mean-variance spanning techniques. • Investment in synthetic strategies is suited to risk tolerant investors, while investment in physical strategies is more suited for risk averse investors.

Investment in Financial Information and Portfolio Performance

Financial information allows investors to condition the portfolio allocation on valuable signals on asset returns. Therefore investors have incentives to spend on information gathering. If interpreted correctly, information signals allow investors to obtain higher returns and more efficient portfolios. Since information is costly, wealthier and more risk tolerant investors have stronger incentives to invest in information. Overconfident investors who overstate the value of the information still obtain higher average returns but end up with less efficient portfolios. We study these implications using two unique surveys of customers of a leading Italian bank, with portfolio data and measures of individual investment in financial information. We find that investment in information is positively associated with returns to financial wealth and negatively associated with the portfolio Sharpe ratio. Furthermore, the latter falls with proxies of overconfidence. We relate these findings to the wealth inequality debate.

Buy-and-Hold and Constant-Mix May Be Better Allocation Strategies Than You Think

Given mean-reverting equity and interest rate uncertainty, this article shows a relatively low economic cost of using a simple allocation strategy, buy-and-hold or constant-mix, instead of optimal reallocation. Moreover, given the decision to use one of the simple allocation strategies, the article identifies (1) which investors will be better off with buy-and-hold than with constant-mix, and vice versa, and (2) which investors will be better off with a horizon-maturity fixed-income position than with a sequence of short-maturity ones, and vice versa. The article uses illustrations in a three-period binomial model to bridge the academic/practitioner gap and provide useful insights to those interested in applied investment management. TOPICS:Portfolio management/multi-asset allocation, portfolio theory, portfolio construction Key Findings • Given mean-reverting equity and uncertain interest rates, investors sacrifice little in expected utility by replacing the optimal reallocation strategy with a simpler allocation strategy of either buy-and-hold or constant-mix. • Traditional investors, with positive allocations to both equity and fixed income, are better off with constant-mix than with buy-and-hold and with allocating to a horizon-maturity fixed-income instrument rather than a sequence of single-period fixed-income instruments. • More risk-tolerant investors with levered equity positions are better off with buy-and-hold than with constant-mix and with levering by a sequence of single-period fixed-income instruments instead of a horizon-maturity fixed-income instrument.

Establishing AN Association between Risk Tolerance and Behavioral Biases among Indian Investors

Behavioral Finance Literature Has Shown A Mushroom Growth In The Recent Years. Literature Shed Specific Light On How The Concept Evolved And Later Developed To Various Stages Which Helped To Understand Various Market Anomalies And The Psychology Of Individuals Through Behavioral Biases. Behavioral Finance Tries To Explain The Logic Behind Applying Of Heuristics Or Shortcuts By Investors To Take Investment Decisions Which Still Need To Be Extensively Studied. The Study Here Attempts For Identify Presence Of Different Biases In Individual Decision Making And Their Association With The Risk Tolerance Capacity. The Results Indicate That Heuristic Biases (I.E. Representativeness Bias, Overconfidence Bias And Gamblers Fallacy Bias) Are Linked To Moderate To High Risk Tolerant Investors. While Herd Bias And Prospect Biases (Loss Aversion Bias And Mental Accounting Bias) Are Found To Be Linked With Low To Moderate Risk Tolerance Levels Of Investors. Heuristics Are Positively Correlated With Risk Tolerance However; Prospect And Herd Are Found To Be Negatively Correlated With Risk Tolerance.

Portfolio rebalancing in general equilibrium

This paper develops an overlapping generations model of optimal rebalancing where agents differ in age and risk tolerance. Equilibrium rebalancing is driven by a leverage effect that influences levered and unlevered agents in opposite directions, an aggregate risk tolerance effect that depends on the distribution of wealth, and an intertemporal hedging effect. After a negative macroeconomic shock, relatively risk-tolerant investors sell risky assets, while more risk-averse investors buy them. Owing to interactions of leverage and changing wealth, however, all agents have higher exposure to aggregate risk after a negative macroeconomic shock and lower exposure after a positive shock.

Event-Driven Strategies in Crypto Assets

Due to structural, regulatory and security-related advantages, crypto assets attract an unparalleled attention all over the world and lead to a heated discussion, whether crypto assets can be considered as a viable option for alternative investments. However, aside from regulatory uncertainty, a lack of profound academic studies and quantitative time series analysis seems to be a vast entry barrier for institutional investors, leading to the fact that the majority share of crypto assets are still being held by young, risk-tolerant retail investors, with high affinity for blockchain technology and innovation. This paper applies important findings of asset pricing theory on the rising academic field of crypto assets and deduces practical implications for retail and institutional investors. Our study includes descriptive statistics and correlation analysis of crypto and capital markets, as well as an event and price impact analysis. Our empirical findings document no evidence for an increase of market efficiency of crypto assets as proxied by bitcoin and reveal significant inefficiencies, leaving valid arguments for either passive or active investment strategies. In addition, our event study findings show significant evidence for insider trading which should call market regulators for actions to fight tax regulations and ensure a fair market environment.

Industry structure, macroeconomic fundamentals and return on equity

PurposeThe purpose of this paper is to examine the impact of industry structure and macroeconomic indicators on return on equity (ROE) of listed financial services firms.Design/methodology/approachHerfindahl–Hirschman Index concentration scales were used to categorise industries into competitive, moderate and concentrated segments, while Arbitrage Pricing Model principles were used to capture the effect of macroeconomic fundamentals on ROE. Generalised method of moments estimator was used to model random effects which were supported by the Hausman test.FindingsFindings suggest that the influence of macroeconomic fundamentals on ROE deteriorates as one moves from competitive to concentrated industries. ROE is volatile in concentrated markets and less volatile in competitive markets. Concentrated markets generally enjoy monopoly profits. Gross domestic product and interest rates have a positive impact on ROE, while inflation, unemployment and exchange rates have a negative effect.Originality/valueThis study highlights the need to apply appropriate business strategies and policies depending on the structure of the industry. Competitive advantage strategies may assist in sustaining profits of firms in competitive markets. Regulators need to be proactive and stress test the impact of a policy on industry performance before implementation because competitive and concentrated markets react differently to external shocks. Risk tolerant investors may invest in volatile markets such as Russia and South Africa, while risk-averse investors may prefer to invest in less volatile markets such as India and China.

The Economics of PIPEs

This paper considers a sample of 3,001 private investments in public equities (PIPEs). Issuing firms tend to be small and poorly performing, so have limited access to traditional sources of finance. To attract capital, they offer shares in a PIPE at a substantial discount to the market price, along with warrants and a collection of other rights. Because of the discount at issuance, PIPE returns decline with the holding period, which itself is a function of registration status and liquidity of the shares issued in the PIPE. Assuming that the PIPE investor sells 10% of volume each day following the issuance, the average PIPE investor holds the stock for 384 days and earns an abnormal return of 21.2%. More risky firms tend to raise capital from relatively risk tolerant investors such as hedge funds and private equity funds. PIPEs issued to more constrained firms have higher holding period adjusted returns but these returns are more volatile. The abnormal holding period adjusted returns earned by PIPE investors appear to be compensation for providing capital to otherwise constrained firms.

Risk Aversion, Noise, and Optimal Investments

In contrast to the efficient market hypothesis (EMH), the noisy market hypothesis (NMH) asserts that prices are but noisy indications of fundamental values. The authors study losses in certainty equivalents of investing according to one hypothesis (NMH or EMH) when the other is true. Their findings suggest that, for reasonable parameter values, investing according to the EMH when the NMH is true yields lower losses than investing according to the NMH when the EMH is true. Further, investing according to the right hypothesis is much more important for risk-tolerant investors than for risk-averse investors.

Dispositional optimism and stock investments

This paper analyzes the relationship between dispositional optimism and stock investments, controlling for cognitive skills and personality traits such as trust, social interactions and risk aversion. We use data from the Survey of Health, Ageing and Retirement in Europe (SHARE) on investors aged 50+ in twelve European countries. Our results show that dispositional optimism and personality matter for financial decisions. Optimism is positively and significantly related to both the ownership of stocks and the share of gross financial wealth invested in these assets and its role is especially relevant for risk tolerant investors and investors with little trust in others.

The demand of energy from an optimal portfolio choice perspective

This paper analyses the demand for energy sector by employing a model form strategic asset allocation literature and quantifying the welfare losses incurred by an investor due to sub-optimal asset allocation. Our sample group includes fifteen major oil producing and consuming countries. We analyze the short-run and long-run desirability of energy sector in the optimal portfolio of an investor with varying level of risk aversion; that is, risk averse and risk tolerant investors. Our results show that the portfolio demand for energy sector is myopic or short-run. For long-run investors, investing in a portfolio of equity market and government bonds is a better proposition. In addition, energy sector is more desirable for risk tolerant investors.

Bargain hunting in the low oil price environment: key issues for investors when bidding for hydrocarbons in new frontiers

New hydrocarbon frontiers open for various reasons, including technological advances and beneficial economic conditions. In this article, the authors focus on countries opening for business because of political changes and how foreign entrants can best manage investment risk in these countries. Investing in frontier markets may be challenging for a number of reasons, however, the prize for overcoming these challenges can be significant. In the current low oil price environment, risk tolerant investors may see a perfect buying opportunity in promising frontiers. The authors provide an overview of ten key issues (such as political risk and local law risk) that, regardless of the oil price, investors should consider before bidding for oil and gas assets in frontier markets and advise on effective mitigation strategies.

Demographic and Socioeconomic Impact on Risk Attitudes of the Indian Investors - An Empirical Study

Investor behavior and investment activities are strongly influenced by the risk tolerance level of individual investors. International evidence suggests that lower risk tolerant investors are generally risk averse. However, their demographic characteristics and socioeconomic factors drive their risk attitudes. This study aims at investigating the critical role that age, gender, marital/social status, number of dependents, educational qualifications, employment and income status, savings pattern, future monetary planning, investments amount and returns from investments play in influencing risk tolerance and thereby finding whether the individual investors are risk averse or risk prone. To fulfill these objective 12 questions representing hypotheses were asked to 200 individual investors investing regularly in the Indian stock markets. A risk tolerance points scale is prepared to analyze the risk attitudes overall and each factor wise, and a Binary Logit Model is applied to validate these results. On an overall basis, this study finds that the responded investors have a lower risk tolerance level which makes them highly risk averse. In line with the hypotheses drawn, this study proves that aged investors are more risk averse than their younger, inexperienced counterparts; married investors with children and other dependents are more risk averse than their unmarried and with less dependents counterparts; higher education brings risk tolerance attitude and thereby makes investors risk prone; higher income and savings also decrease risk aversion whereas future planning approach increases risk aversion. It is also found under this study that higher investments amount and returns from such investments increase the risk tolerance level and thus reduces risk aversion of these investors. However, contradictorily with the undertaken hypotheses, this study finds that women investors are more risk prone than their male counterparts, and employment status of the respondents is immaterial in regard to their risk attitude. Binary Logit Model results also mostly validate the above results except that it finds no impact of number

Financial Literacy, Cognitive Ability and Financial Advice-Seeking

This paper aims at identifying the possible link between financial literacy, cognitive ability and the propensity to seek financial expert help. We use bank and survey data collected from a randomly selected and representative sample of Dutch retail investors. We find that perceived financial literacy is negatively associated with asking for financial expert help in making investment decisions, confirming the competence effect of Heath and Tversky (1991). Consistent with these finding is that perceived financial literacy strongly relates to perceived (dis)advantages of execution-only or advised investing. This supports the idea that financial advice serves a substitute role for those who view themselves as less financially literate. Both measured financial literacy and cognitive ability are not related to advice seeking, which implies that advice is not a sufficient remedy for low literate or low cognitive able individuals. We also document some other interesting determinants of advice-seeking. Low educated and risk-tolerant investors exhibit a lower propensity to seek advice, while wealthy, older investors who place trust in advisers seek advice more often.

Spending Flexibility and Safe Withdrawal Rates

Shortfall risk retirement income analyses offer little insight into how much risk is optimal, and how risk tolerance affects retirement income decisions. This study models retirement income risk in a manner consistent with risk tolerance in portfolio selection in order to estimate optimal asset allocations and withdrawal rates for retirees with different risk attitudes. We find that the 4 percent retirement withdrawal rate strategy may only be appropriate for risk averse clients with moderate guaranteed income sources. The ability to accept greater shortfall probabilities means that risk tolerant investors will prefer a higher withdrawal rate and a riskier retirement portfolio. A risk tolerant client may prefer a withdrawal rate of between 5 and 7 percent with a guaranteed income of $20,000. The optimal retirement portfolio allocation to stock increases by between 10 and 30 percentage points and the optimal withdrawal rate increases by between 1 and 2 percentage points for clients with a guaranteed income of $60,000 instead of $20,000.