DP6532 Preferred Risk Habitat of Individual Investors
|Author(s):||Daniel Dorn, Gur Huberman|
|Publication Date:||October 2007|
|Keyword(s):||preferred risk habitat, risk, risk aversion, stock portfolio, volatility|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=6532|
The preferred risk habitat hypothesis, introduced here, is that individual investors select stocks with volatilities commensurate with their risk aversion; more risk-averse individuals pick lower-volatility stocks. The investors' portfolio perspective overlooks return correlations. The data, 1995-2000 holdings of over 20,000 customers of a German broker, are consistent with the predictions of the hypothesis: the portfolios contain highly similar stocks in terms of volatility, when stocks are sold they are replaced by stocks of similar volatilities, and the more risk averse customers indeed hold less volatile stocks. Cross-sectionally, the more risk averse investors also have a stronger tendency to invest in mutual funds. Major improvements in diversification are concentrated during periods when investors add money to their account.