Preferred Risk Habitat of Individual Investors

56 Pages Posted: 5 Jun 2008

See all articles by Daniel Dorn

Daniel Dorn

Drexel University - Department of Finance

Gur Huberman

Columbia University - Columbia Business School, Finance

Multiple version iconThere are 4 versions of this paper

Date Written: October 2007

Abstract

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.

Keywords: preferred risk habitat, risk, risk aversion, stock portfolio, volatility

JEL Classification: G10

Suggested Citation

Dorn, Daniel and Huberman, Gur, Preferred Risk Habitat of Individual Investors (October 2007). CEPR Discussion Paper No. DP6532, Available at SSRN: https://ssrn.com/abstract=1140059

Daniel Dorn (Contact Author)

Drexel University - Department of Finance ( email )

LeBow College of Business
Philadelphia, PA 19104
United States

Gur Huberman

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)

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