Risk and Loss Aversion Revisited

Abstract

We implement several financial and actuarial methods in order to assess investors’ risk and loss aversion. This article sheds another light on the risk characteristics of U.S. equity markets across different historical periods and their respective implied risk and loss aversion. First, we show that our selected risk measures depend upon market factors such as excess return and volatility. Consequently, for some historical periods, equity markets display implied risk aversion coefficients far below the ones found in previous literature. Furthermore, we investigate to what extent the proportion of risky assets held in one’s portfolio influences our risk measures. We find that the presence of risky assets, even in small proportion to one’s portfolio, still requires substantial tolerance to risk. As a result, we recommend that financial institutions should formalize the assessment of risk aversion quantitatively in order to match their offers with their clients’ individual characteristics.

TOPICS: Portfolio theory, risk management