Hostname: page-component-78c5997874-8bhkd Total loading time: 0 Render date: 2024-11-14T16:51:11.085Z Has data issue: false hasContentIssue false
  • English
  • Français

Risk Aversion in a Dynamic Asset Allocation Experiment

Published online by Cambridge University Press:  19 September 2018

Isabelle Brocas ,
Juan D. Carrillo ,
Aleksandar Giga  and
Fernando Zapatero
Get access Rights & Permissions [Opens in a new window]

Abstract

We conduct a controlled laboratory experiment in the spirit of Merton (1971), in which subjects dynamically choose their portfolio allocation between a risk-free and risky asset. Using the optimal allocation of an investor with hyperbolic absolute risk aversion (HARA) utility, we fit the experimental choices to characterize the risk profile of our participants. Despite substantial heterogeneity, decreasing absolute risk aversion and increasing relative risk aversion are the predominant types. We also find some evidence of increased risk taking after a gain. Finally, the session level risk attitudes show a different profile than the individual descriptions of risk attitudes.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 54 , Issue 5 , October 2019 , pp. 2209 - 2232
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank Elena Asparouhova (the referee), Jennifer Conrad (the editor), Glenn Harrison, Alex Imas, and the members of the Los Angeles Behavioral Economics Laboratory (LABEL); participants (and especially discussants) of the 2015 Western Finance Association meetings (Thomas Gilbert); the 2014 CEAR/MRIC Workshop at Georgia State University; the 2015 Economic Science Association meeting, and the 2014 seminar at USC for their helpful comments and suggestions. We thank the LUSK Center for Real Estate for their financial support.

References

Abeler, J.; Falk, A.; Goette, L.; and Huffman, D.. “Reference Points and Effort Provision.” American Economic Review, 101 (2011), 470–492.Google Scholar
Andersen, S.; Harrison, G. W.; Lau, M. I.; and Rutström, E. E.. “Elicitation Using Multiple Price List Formats.” Experimental Economics, 9 (2006), 383–405.Google Scholar
Andersen, S.; Harrison, G. W.; Lau, M. I.; and Rutström, E. E.. “Risk Aversion in Game Shows.” In Risk Aversion in Experiments, Vol. 12, Cox, J. C. and Harrison, G. W., eds. Bingley, UK: Emerald Group Publishing (2008), 359–404.Google Scholar
Arrow, K. J. Essays in the Theory of Risk Bearing. Chicago, IL: Markham (1971).Google Scholar
Asparouhova, E.; Bossaerts, P.; Roy, N.; and Zame, W.. “‘Lucas’ in the Laboratory.” Journal of Finance, 71 (2016), 2727–2780.Google Scholar
Assenza, T.; Bao, T.; Hommes, C.; and Massaro, D.. “Experiments on Expectations in Macroeconomics and Finance.” In Experiments in Macroeconomics, Research in Experimental Economics, Vol. 17, Duffy, J., ed. Bingley, UK: Emerald Group Publishing Limited (2014), 11–70.Google Scholar
Becker, G. M.; DeGroot, M. H.; and Marschak, J.. “Measuring Utility by a Single-Response Sequential Method.” Behavioral Science, 9 (1964), 226–232.Google Scholar
Binswanger, H. P.“Attitudes Toward Risk: Experimental Measurement in Rural India.” American Journal of Agricultural Economics, 62 (1980), 395–407.Google Scholar
Bossaerts, P.; Ghirardato, P.; Guarnaschelli, S.; and Zame, W. R.. “Ambiguity in Asset Markets: Theory and Experiment.” Review of Financial Studies, 23 (2010), 1325–1359.Google Scholar
Bossaerts, P.; Meloso, D.; and Zame, W.. “Dynamically Complete Experimental Asset Markets.” Working Paper, University of Melbourne (2008).Google Scholar
Bossaerts, P., and Plott, C.. “Basic Principles of Asset Pricing Theory: Evidence from Large-Scale Experimental Financial Markets.” Review of Finance, 8 (2004), 135–169.Google Scholar
Bossaerts, P.; Plott, C.; and Zame, W. R.. “Prices and Portfolio Choices in Financial Markets: Theory, Econometrics, Experiments.” Econometrica, 75 (2007), 993–1038.Google Scholar
Brocas, I.; Carrillo, J. D.; Giga, A.; and Zapatero, F.. “Skewness Seeking in a Dynamic Portfolio Choice Experiment.” Working Paper, University of Southern California (2019).Google Scholar
Campbell, J. Y., and Cochrane, J. H.. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy, 107 (1999), 205–251.Google Scholar
Charness, G.; Gneezy, U.; and Imas, A.. “Experimental Methods: Eliciting Risk Preferences.” Journal of Economic Behavior & Organization, 87 (2013), 43–51.Google Scholar
Choi, S.; Fisman, R.; Gale, D.; and Kariv, S.. “Consistency and Heterogeneity of Individual Behavior Under Uncertainty.” American Economic Review, 97 (2007), 1921–1938.Google Scholar
Cox, J. C., and Huang, C. F.. “Optimal Consumption and Portfolio Policies When Asset Prices Follow a Diffusion Process.” Journal of Economic Theory, 49 (1989), 33–83.Google Scholar
Duffie, D., and Protter, P.. “From Discrete to Continuous-Time Finance: Weak Convergence of the Financial Gain Process.” Mathematical Finance, 2 (1992), 1–15.Google Scholar
Eckel, C. C., and Grossman, P. J.. “Forecasting Risk Attitudes: An Experimental Study Using Actual and Forecast Gamble Choices.” Journal of Economic Behavior & Organization, 68 (2008), 1–17.Google Scholar
Epstein, L. G., and Zin, S. E.. “Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework.” Econometrica, 57 (1989), 937–969.Google Scholar
Ericson, K. M. M., and Fuster, A.. “Expectations as Endowments: Evidence on Reference-Dependent Preferences from Exchange and Valuation Experiments.” Quarterly Journal of Economics, 126 (2011), 1879–1907.Google Scholar
Friedman, D.; Isaac, R. M.; James, D.; and Sunder, S.. Risky Curves: On the Empirical Failure of Expected Utility. London, UK: Routledge (2014).Google Scholar
Friedman, D., and Oprea, R.. “A Continuous Dilemma.” American Economic Review, 102 (2012), 337–363.Google Scholar
Frydman, C.; Barberis, N.; Camerer, C.; Bossaerts, P.; and Rangel, A.. “Using Neural Data to Test a Theory of Investor Behavior: An Application to Realization Utility.” Journal of Finance, 69 (2014), 907–946.Google Scholar
Gill, D., and Prowse, V.. “A Structural Analysis of Disappointment Aversion in a Real Effort Competition.” American Economic Review, 102 (2012), 469–503.Google Scholar
Gneezy, U., and Potters, J.. “An Experiment on Risk Taking and Evaluation Periods.” Quarterly Journal of Economics, 112 (1997), 631–645.Google Scholar
Harrison, G. W., and Rutström, E. E.. “Risk Aversion in the Laboratory.” In Risk Aversion in Experiments, Vol. 12, Cox, J. C. and Harrison, G. W., eds. Bingley, UK: Emerald Group Publishing (2008), 41–196.Google Scholar
Haruvy, E., and Noussair, C. N.. “The Effect of Short Selling on Bubbles and Crashes in Experimental Spot Asset Markets.” Journal of Finance, 61 (2006), 1119–1157.Google Scholar
Hey, J. D., and Orme, C.. “Investigating Generalizations of Expected Utility Theory Using Experimental Data.” Econometrica, 62 (1994), 1291–1326.Google Scholar
Holt, C. A., and Laury, S. K.. “Risk Aversion and Incentive Effects.” American Economic Review, 92 (2002), 1644–1655.Google Scholar
Imas, A.“The Realization Effect: Risk-Taking After Realized versus Paper Losses.” American Economic Review, 106 (2016), 2086–2109.Google Scholar
Jacobson, S., and Petrie, R.. “Learning From Mistakes: What Do Inconsistent Choices Over Risk Tell Us? ” Journal of Risk and Uncertainty, 38 (2009), 143–158.Google Scholar
Kahneman, D., and Tversky, A.. “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica, 47 (1979), 263–291.Google Scholar
Karatzas, I.; Lehoczky, J. P.; and Shreve, S. E.. “Optimal Portfolio and Consumption Decisions for a ‘Small Investor’ on a Finite Horizon.” SIAM Journal on Control and Optimization, 25 (1987), 1557–1586.Google Scholar
Knetsch, J. L., and Wong, W.-K.. “The Endowment Effect and the Reference State: Evidence and Manipulations.” Journal of Economic Behavior & Organization, 71 (2009), 407–413.Google Scholar
Kőszegi, B., and Rabin, M.. “A Model of Reference-Dependent Preferences.” Quarterly Journal of Economics, 121 (2006), 1133–1165.Google Scholar
Kroll, Y., and Levy, H.. “Further Tests of the Separation Theorem and the Capital Asset Pricing Model.” American Economic Review, 82 (1992), 664–670.Google Scholar
Kroll, Y.; Levy, H.; and Rapoport, A.. “Experimental Tests of the Separation Theorem and the Capital Asset Pricing Model.” American Economic Review, 78 (1988), 500–519.Google Scholar
Levy, H.“Absolute and Relative Risk Aversion: An Experimental Study.” Journal of Risk and Uncertainty, 8 (1994), 289–307.Google Scholar
Levy, H., and Levy, M.. “Prospect Theory and the Investment Horizon.” Working Paper, Hebrew University of Jerusalem (2017).Google Scholar
Lusardi, A.; Samek, A.; Kapteyn, A.; Glinert, L.; Hung, A.; and Heinberg, A.. “Visual Tools and Narratives: New Ways to Improve Financial Literacy.” Journal of Pension Economics & Finance, 16 (2017), 297–323.Google Scholar
Maier, J., and Rüger, M.. “Measuring Risk Aversion Model-Independently.” Working Paper, University of Munich (2012).Google Scholar
Merton, R. C.“Optimum Consumption and Portfolio Rules in a Continuous-Time Model.” Journal of Economic Theory, 3 (1971), 373–413.Google Scholar
Plott, C. R., and Sunder, S.. “Rational Expectations and the Aggregation of Diverse Information in Laboratory Security Markets.” Econometrica, 56 (1988), 1085–1118.Google Scholar
Post, T.; Van den Assem, M. J.; Baltussen, G.; and Thaler, R. H.. “Deal or No Deal? Decision Making Under Risk in a Large-Payoff Game Show.” American Economic Review, 98 (2008), 38–71.Google Scholar
Rapoport, A.“Effects of Wealth on Portfolios Under Various Investment Conditions.” Acta Psychologica, 55 (1984), 31–51.Google Scholar
Rapoport, A.; Zwick, R.; and Funk, S. G.. “Selection of Portfolios With Risky and Riskless Assets: Experimental Tests of Two Expected Utility Models.” Journal of Economic Psychology, 9 (1988), 169–194.Google Scholar
Smith, V. L.; Suchanek, G. L.; and Williams, A. W.. “Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets.” Econometrica, 56 (1988), 1119–1151.Google Scholar
Sokol-Hessner, P.; Hsu, M.; Curley, N. G.; Delgado, M. R.; Camerer, C. F.; and Phelps, E. A.. “Thinking Like a Trader Selectively Reduces Individuals’ Loss Aversion.” Proceedings of the National Academy of Sciences, 106 (2009), 5035–5040.Google Scholar
Sundali, J. A., and Guerrero, F.. “Managing a 401 (k) Account: An Experiment on Asset Allocation.” Journal of Behavioral Finance, 10 (2009), 108–124.Google Scholar
Thaler, R. H., and Johnson, E. J.. “Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice.” Management Science, 36 (1990), 643–660.Google Scholar
Wang, S. W.; Filiba, M.; and Camerer, C. F.. “Dynamically Optimized Sequential Experimentation (DOSE) for Estimating Economic Preference Parameters.” Working Paper, California Institute of Technology (2010).Google Scholar
Supplementary material: File

Brocas et al. supplementary material

Brocas et al. supplementary material 1

Download Brocas et al. supplementary material(File)
File 1.1 MB