Working Paper: CEPR ID: DP6532
Authors: Daniel Dorn; Gur Huberman
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 Codes: G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Risk Aversion (D81) | Average Component Volatility (ACV) (C58) |
| Risk Aversion (D81) | Herfindahl-Hirschman Index (HHI) (L19) |
| Average Component Volatility (ACV) (C58) | Stock Selection Behavior (G11) |
| Risk Aversion (D81) | Stock Volatility Selection (G17) |
| Risk Aversion (D81) | Mutual Fund Investment (G23) |
| Stock Selection Behavior (G11) | Portfolio Diversification (G11) |