Preferred Risk Habitat of Individual Investors
58 Pages Posted: 10 Mar 2008 Last revised: 23 Jul 2011
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Preferred Risk Habitat of Individual Investors
Preferred Risk Habitat of Individual Investors
Preferred Risk Habitat of Individual Investors
Date Written: March 10, 2009
Abstract
The preferred risk habitat hypothesis, introduced here, is that individual investors select stocks whose volatilities are commensurate with their risk aversion. The data, 1995-2000 holdings of over 20,000 clients at a large German broker, are consistent with the predictions of the hypothesis: the returns of stocks within each portfolio have remarkably similar volatilities, when stocks are sold they are replaced by stocks of similar volatilities, and the more risk averse customers indeed hold less volatile stocks. Greater volatility specialization is associated with lower Sharpe ratios, primarily because more specialized investors hold fewer stocks and thereby expose themselves to more unsystematic risk.
Keywords: portfolio choice, narrow framing, investor behavior, volatility, risk aversion, diversification
JEL Classification: G11, D14, D81
Suggested Citation: Suggested Citation
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