A Behavioral Theory of the Effect of the Risk-Free Rate on the Demand for Risky Assets

Forthcoming, Journal of Behavioral and Experimental Economics

17 Pages Posted: 12 Jul 2018

See all articles by Yoav Ganzach

Yoav Ganzach

Tel Aviv University - Coller School of Management

Avi Wohl

Tel Aviv University - Coller School of Management

Date Written: June 1, 2018

Abstract

We suggest a behavioral perspective for the demand for risky assets (DRA) in which the risk-free rate affects this demand: the lower the risk-free rate the higher the demand for risky assets. This perspective is based on the idea that changes in return exhibit decreasing sensitivity, that is, the impact of a change diminishes with the distance from the status quo (or reference point). We begin by demonstrating that when the risk-free rate decreases, DRA increases even among sophisticated subjects. We then provide support for our behavioral model in three experiments in which the risk-free rate is manipulated and demand for risky assets is measured. Experiments 1 and 2 rule out alternative explanations, demonstrating that decreasing sensitivity underlies, at least in part, the effect of the risk-free rate on DRA. Experiment 3 demonstrates the role of decreasing sensitivity when returns are presented in terms of monetary payoffs rather than interest rates.

Keywords: Risk-Free Rate; Demand for Risky Assets; Decreasing Marginal Sensitivity; Risk Perception; Prospect Theory

JEL Classification: G02; G11

Suggested Citation

Ganzach, Yoav and Wohl, Avi, A Behavioral Theory of the Effect of the Risk-Free Rate on the Demand for Risky Assets (June 1, 2018). Forthcoming, Journal of Behavioral and Experimental Economics, Available at SSRN: https://ssrn.com/abstract=3206174

Yoav Ganzach (Contact Author)

Tel Aviv University - Coller School of Management ( email )

Ramat Aviv
Tel-Aviv, 6997801
Israel

Avi Wohl

Tel Aviv University - Coller School of Management ( email )

P.O. Box 39010
Ramat Aviv, Tel Aviv, 69978
Israel
+972 3 6409051 (Phone)

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