Working Paper: CEPR ID: DP14955
Authors: Laurent Calvet; Claire Celerier; Paolo Sodini; Boris Vallee
Abstract: This paper shows that securities with a non-linear payoff design can foster household risk-taking. We demonstrate this effect empirically by exploiting the introduction of capital guarantee products in Sweden from 2002 to 2007. The fast and broad adoption of these products is associated with an increase in expected financial portfolio returns, which is especially strong for households with a low risk appetite ex ante. We explore possible economic explanations by developing a life-cycle model of consumption-portfolio decisions. The capital guarantee substantially increases risk-taking by households with pessimistic beliefs or preferences combining loss aversion and narrow framing. The welfare gains from financial innovation are stronger for households that are less willing to take risk ex ante. Our results illustrate how security design can mitigate behavioral biases and enhance economic well-being.
Keywords: security design; household finance; capital guarantee product; behavioral biases; risk taking
JEL Codes: I22; G1; D18; D12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Interaction of loss aversion and narrow framing (G41) | Amplification of risktaking behavior (D91) |
| Introduction of CGPs (D58) | Increase in expected financial portfolio returns (G11) |
| Households adopting CGPs (D19) | Increase in risktaking index (G41) |
| CGP investment share (E20) | Increase in risktaking index (G41) |
| Households with low risk appetite (G51) | Increase in risktaking index (G41) |