Risk appetite and (mis)pricing

The dissertation explores the effect of different constrained portfolio strategies on investors' welfare. A constrained portfolio strategy gives investors a sub-optimal asset allocation that results in investors' welfare losses. To measure those welfare losses I compare constrained portfolios with optimal portfolios by using the concept of the proportionate opportunity cost along with various CRRA utility functions.;Chapter 1 discusses reasons the investors use constrained portfolio strategies, describes the different constrained portfolio strategies that are used in the dissertation, derives the proportionate opportunity cost, describes the derivation of the joint probability distribution functions for asset returns, and describes the way the historical extreme asset returns values are exaggerated to check the robustness of the estimates of the proportionate opportunity cost.;The first essay, in Chapter 2, analyzes investors' welfare losses from being constrained to choose a mean-variance efficient portfolio. I show that the mean-variance strategy shows a moderately good approximation to the optimal portfolio strategy. When extreme values of returns are not exaggerated in the returns distribution, investors' welfare losses do not exceed 5.6% of initial wealth. With extreme returns values exaggerated in the returns distribution, investors' welfare losses do not exceed 11% of initial wealth.;The second essay, in Chapter 3, analyzes investors' welfare losses from investing in a non-well-diversified number of assets. The analysis is performed with and without a short-selling constraint. I show that without the short-selling constraint and with no exaggeration of extreme values of asset returns the lowest well-diversified number of assets for an investor with low risk aversion is 24. The number decreases as the level of risk aversion increases, and when the short-selling constraint is introduced.;The second part of the chapter explores investors' welfare losses when they restrict themselves to either stocks or bonds but not both. I show that for investors with low levels of risk aversion welfare losses do not exceed 1.5% of initial wealth when they invest in only one type of assets. For investors with medium and high levels of relative risk aversion, constrained portfolios that include only one type of assets, stocks only or bonds only, along with Treasury bills, give expected utility about as high as unconstrained portfolios that include both types of assets, stocks and bonds.;The third essay, in Chapter 4, analyzes investors' welfare losses from being restricted from short selling. I show that with a nominally risk-free asset the optimal portfolio strategy with the short-selling constraint performs almost as

The theoretical attitude and actual behavior of an individual towards risk

The paper performs a (Panel) Moderated Regression, Causality and Cointegration (complete version) test on the relationship between the exchange rate of major selected cryptocurrencies vs. major fiat currencies, and selected technology indices of various geographic areas and economic groups in the world, representative of different countries or areas in the world (Europe) and for different levels of market capitalization. The dataset allows to focus on the comparison pre- and post-Covid19 (complete version), testing the relationship in those two different time frames. The novelty of the study is the use of risk aversion and VIX volatility index (market sentiment) as control variables. Various indices of risk aversion have been developed, presenting different levels of trade-off in terms of availability (ease of calculation) and effectiveness. A good candidate seems to be the Global Risk Appetite Index (GRAI) by Kumar and Persaud (2002). As for the VIX index, it has been widely used as a proxy of market sentiment, but rarely applied to the understanding of currency trends (especially cryptocurrency). Our expectation is to observe some significant moderation effect for some of the indicators considered, in general and when observing the data for different sub-periods. with investors probably trying to hedge equity investments and diversify their portfolios differently, with risk aversion and VIX index to be a driving factor of those choices. We also expect results to be confirmed by the Causality and Cointegration (complete version) test. The paper aims to contribute to the Fintech literature and shed light on the possibilities of diversification offered by tech-related portfolios. As a corollary, it aims to determine how the effect of risk aversion and general market risk sentiment drives those choices. Keywords: Cryptocurrency; Technology Index; Risk Appetite; Market Sentiment; Causality; Cointegration; Panel Regression.

ABSTRACTMost Israelis live in big and small cities and two neighborhood types that are unique to Israel – the moshav and the kibbutz – thus offering a natural experimental field for exploring the relationship between place of residence and general and financial risk aversion. Based on a sample of 528 questionnaires, this study found that independent of one’s place of residence respondents proved more risk averse in their general decision-making than with regard to financial issues. The kibbutz respondents demonstrated the highest average level of risk aversion, followed by small-city dwellers, big-city residents, and moshav members. The kibbutz level of risk aversion is inconsistent with the Cushion Hypothesis, while the lowest level of risk aversion demonstrated by moshav residents suggests that facing an independent lifestyle and significant dilemmas on a daily basis reduces not only the individual’s level of risk aversion in general, but also the level of intimidation associated with financial issues.

Chapter 2This chapter examines the extent to which gender differences in risk aversion explain why women have a lower entrepreneurship rate, earn less, and work fewer hours than men. Data from the NLSY79 confirms previous findings that women are more risk averse than men. However, while less risk averse men tend to become self-employed, there is no significant effect of risk aversion on women's entrepreneurship decisions. Similarly, greater risk aversion increases earnings for male entrepreneurs, but it has no effect on female entrepreneurial earnings. More risk aversion lowers female wages, but the effects are of modest magnitude. On the contrary, more risk aversion raises male wages. Risk aversion does not explain variation in hours of work for either men or women. These findings and standard decomposition suggest that widely reported differences in risk aversion across genders play only a trivial role in explaining gender gaps in labor market outcomes.Chapter 3While more risk averse individuals are less likely to become entrepreneurs, theory predicts that more risk averse entrepreneurs pick ventures with higher expected returns and so they should survive in business longer than their less risk averse counterparts. Using successive entry cohorts of young entrepreneurs in the NLSY79, we find contrary to theory that the most successful entrepreneurs are the least risk averse. This surprising finding suggests that commonly used measures of risk aversion are not indicators of taste toward risk. Instead, measured risk aversion signals weak entrepreneurial ability--the least risk averse are apparently those who can best assess and manage risks. Indeed, our interpretation is consistent with recent experimental evidence linking cognitive ability with a greater willingness to accept risk.Chapter 4The fourth chapter investigates the stability of measured risk attitudes over time, using a 13-year longitudinal sample of individuals in the NLSY79. A variance decomposition shows that 57% of the total variance in measured risk aversion is attributable to variation in measured risk aversion within individuals and only 43% to variation across individuals. After removing variation attributable to socioeconomic factors, the proportion of within variance drops to 54%, strongly rejecting the presumption that measured risk attitudes are stable over time. We find that an individual's measured risk aversion changes systematically responding to personal economic circumstances. Measured risk aversion responds to fluctuations in employment: duration of employment spells and out of labor force increases risk aversion whereas length of unemployment spells decreases risk aversion. Previous labor market experience also increases risk aversion. Finally, risk aversion is quadratic in age and net family income with an inverted U-shape. Our analysis shows that measured risk aversion cannot be treated as a fixed attitude toward risk but rather a changing attitude that reflects changes in personal economic circumstances.Chapter 5In Lazear (2005)'s model of entrepreneurship, individuals with more diverse academic and occupational training are more likely to become entrepreneurs, while more narrowly trained individuals become employees. This chapter examines whether Lazear's model can also explain which individuals become nonprofit entrepreneurs. Information on successive cohorts of college graduates from a single university from 1982-2006 show that observed diversity of academic and occupational skills increases the probability of nonprofit sector entrepreneurship, consistent with previous findings of for-profit entrepreneurs. In addition, unobservable talents that increase probability of for-profit startups are positively correlated with the unobservable skills that lead to nonprofit start-ups, consistent with a presumed entrepreneurial skill that underlies the Lazear Jack-of-All-Trades model.

The use of nitrogen (N) fertilizer substantially contributes to greenhouse gas (GHG) emissions due to N2O emissions from agricultural soils and energy-intensive fertilizer manufacturing. Thus, a reduction of mineral N fertilizer use can contribute to reduced GHG emissions. Fertilizer tax is a potential instrument to provide incentives to apply less fertilizer and contribute to the mitigation of GHG emissions. This study provides model results based on a production function analysis from field experiments in Brandenburg and Schleswig-Holstein, with respect to risk aversion by calculating certainty equivalents for different levels of risk aversion. The model results were used to identify effective and cost-efficient options considering farmers’ risk aversion to reduce N fertilizer, and to compare the potential and cost of GHG mitigation with different N fertilizer tax schemes. The results show that moderate N tax levels are effective in reducing N fertilizer levels, and thus, in curbing GHG emissions at costs below 100 €/t CO2eq for rye, barley and canola. However, in wheat production, N tax has limited effects on economically optimal N use due to the effects of N fertilizer on crop quality, which affect the sale prices of wheat. The findings indicate that the level of risk aversion does not have a consistent impact on the reduction of N fertilizer with a tax, even though the level of N fertilizer use is generally lower for risk-averse agents. The differences in N fertilizer response might have an impact on the relative advantage of different crops, which should be taken into account for an effective implementation of a tax on N fertilizer.

An Empirical Analysis of the Role of Risk Aversion in Executive Compensation Contracts

Based on the study of irrational managers in behavioral corporate finance, this paper proposes a financing decision-making model by the construction of investors' rationality and analysis to managers' risk-aversion. Measuring managerial risk aversion under behavioral corporate finance paradigm according to risk aversion index, this paper analyzes the financing behavior of risk-averse managers by means of analyzing DJ-China 88 index from 2000 to 2004 through Logistic regression and mean analysis. The findings show that if other variables are well-controlled, then the risk-averse index has an obvious negative influence on debt financing decision. The higher is the level of risk-aversion, the less is the likelihood of application of debt financing, which means risk-averse managers prefer stock financing.

Rainfall-induced slope failures disrupt the traffic and warrant urgent slope repair works. The impact of roadside slope failures can be minimized if slopes are proactively rehabilitated. Nonetheless, transportation agencies are constrained in their budget to rehabilitate a limited number of slope segments due to competing maintenance needs among different transportation assets. Therefore, the transportation agencies should identify the critical slope combination that should be proactively rehabilitated under constraint budgets to lessen the impact on the transportation network during extreme rainfall events. The decision-making approach for slope rehabilitation should also ensure low risk associated with the selected rehabilitation strategy. Current slope-rehabilitation decision models do not consider the risk associated with the rehabilitation strategies in the decision-making process. The objective of this study is to develop a risk-averse stochastic combinatorial optimization to facilitate the selection of slope rehabilitation strategies, which leads to the least expected cost and conditional value at risk (CVaR) for extreme rainfall events. The simulated annealing approach is used to solve the risk-averse combinatorial optimization rehabilitation problem with the objective function that measures the total cost of traffic disruption and slope restoration post-failures. The approach is demonstrated using a transportation network in Lamar County, Texas. Unlike a genetic algorithm-based approach in the literature that yields a single slope rehabilitation strategy, the proposed risk-averse simulated annealing approach identifies rehabilitation strategies along the Pareto efficient frontier facilitating the rehabilitation decisions based on the tradeoff between expected cost and CVaR. For the network in Lamar County, the proposed risk-averse simulated annealing provided a solution in the Pareto front that reduced CVaR by 2.0% compared to the solution obtained from the genetic algorithm-based approach while only increasing the expected cost by 0.8%. The risk-averse optimization approach will aid transportation agencies in determining slope rehabilitation strategies for minimizing the impact of rainfall-induced failures at appropriate risk aversion levels.

Risk aversion is an important research area in the field of agricultural economics in the last years. Creating effective and efficient risk management tools in an increasingly volatile economic and natural environment requires proper recognition of farmers’ behavior and attitudes towards risk. In this context, the main aim of the paper was to estimate farmers’ attitudes towards risk and identification of farm’s and farmer’s characteristics in dependency on risk aversion level. The assessment of farmers’ preferences towards risk was based on hypothetical games in a representative sample of 600 Polish farms—participants of Farm Accountancy Data Network (FADN). Based on the interviews with farmers, a relative risk aversion coefficient has been estimated. Results revealed that on average Polish farmers have quite a strong risk aversion. Their attitudes towards risk are strongly linked with their self-assessment regarding their way of making decisions under risk. Some relations between farmers’ risk aversion and perception of selected risk factors could also be observed. The results revealed that the application of specified risk management tools by farmers and their potential reaction to a significant income drop are related to risk aversion level.

Optimal Portfolios for the Long Run

<p style='text-indent:20px;'>This paper studies a supply chain consisting of two unreliable suppliers and a retailer, where the two suppliers' default risks are correlated. We use a mean-variance function to characterize the retailer's risk aversion. In the case of exogenous wholesale prices, we find that the retailer's risk aversion has a non-monotonic effect on its total ordering quantity. We also show that when the suppliers' default correlation increases, the retailer's total ordering quantity is non-increasing. In the case of endogenous wholesale prices, we find that the profits of the suppliers and the retailer are non-monotonic in retailer's risk aversion level or suppliers' default correlation. As risk aversion level increases, the retailer becomes less sensitive to wholesale prices. Finally, the numerical results indicate that when the suppliers' delivery rates are different, the supplier with a low delivery rate can benefit from the retailer's risk aversion under certain conditions.</p>

This paper investigates a dual-channel supply chain with one risk-neutral manufacturer and one risk-averse retailer where there is only one perishable product with price-dependent stochastic demand. We choose Conditional Value-at-Risk criterion to measure the retailer’s risk-averse level, and assume that the manufacturer’s direct sales channel and the retailer’s traditional channel adopt a consistent pricing strategy. The model explores a Nash bargaining problem where the manufacturer and the retailer negotiate with each other on the wholesale price, the retail price and the order quantity when they have equal bargaining power. It is found that when demand uncertainty follows a uniform distribution, a Nash bargaining equilibrium exists and the retail price will decrease as the retailer becomes more risk averse. However, when the risk-averse indicator increases, the manufacturer’s profit on his direct channel will decrease, increase or first increase and then decrease, depending on the values of the related parameters. The profit shares of the manufacturer and the retailer under the Nash equilibrium model are related to the risk-averse indicator of the retailer. Furthermore, we perform three sets of numerical experiments to verify the effects of the retailer’s risk-averse indicator on decision-making and profit allocations under the different environmental parameters and gain several meaningful managerial insights.

This paper develops a matrix-measure of multivariate risk aversion which is related to a notion of risk premium and states the restrictions that must be imposed upon the matrix-measures of two utility functions in order that one require a higher risk premium than another for every small multivariate risk. A necessary and sufficient condition for comparability of global attitude towards risk is that the local restrictions hold over the entire domain. The usefulness of the measures of risk aversion is discussed within the context of a multivariate risk-sharing problem. UNIVARIATE MEASURES OF ABSOLUTE and relative risk aversion were introduced in the seminal works of Pratt [8] and Arrow [1], and have since become indispensable tools for the analysis of risk bearing in situations involving unidimensional risks. Recent years witnessed numerous attempts to generalize various aspects of the Pratt-Arrow notions to the case of multivariate risk (Kihlstrom and Mirman [6], Keeney [5], Duncan [2], Paroush [7], and Stiglitz [9]). The univariate case is qualitatively different from the multivariate case in that the ordinal preferences of all decision makers are identical, whereas in the multivariate case the preference orderings may differ among decision makers. This fact has two important consequences. First, while the analysis of risk bearing in situations involving univariate risks turns out to depend solely upon the cardinal properties of the function representing the ordinal preferences of the decision makers involved, in situations involving multivariate risks, the ordinal preferences themselves play an important role in addition to that of the function representing them. Second, in the univariate case the local measure of absolute risk aversion permits a complete ordering of individuals according to the relation least as risk averse as, whereas in the multivariate case such ordering is not in general independent of the specific risk under consideration. Pratt [8] has shown that the univariate measure of absolute risk aversion satisfies a formal relation to a number which has the interpretation of risk premium. In this study I introduce a matrix measure of absolute multivariate risk aversion which satisfies a similar formal criterion. It should be noted at the outset, however, that in the multivariate case the risk premium may be regarded as a vector of commodities (see, for example, Duncan [2, 3]), and interpersonal comparison of risk aversion is not directional independent. I.e., the ranking of risk

Increasing stress on water availability, driven by rising water demand and climate variability, presents a global challenge. By leveraging advanced ensemble streamflow forecasts and conjunctive management, reoperating existing dams with Forecast-Informed Reservoir Operations coupled with Managed Aquifer Recharge (FIRO-MAR) offers a cost-effective strategy to achieve long-term water sustainability. However, the inherent uncertainty in streamflow forecasts introduces associated risks, necessitating consideration of risk perception respective to the forecast uncertainties in real-world operation decisions. Here, we explore to what extent the value of forecasts in FIRO-MAR is sensitive to operators’ risk aversion levels, which can help us better identify specific risk aversion levels that limit the use of forecasts. We develop a multi-objective reservoir model integrated with downstream groundwater conjunctive use to support additional groundwater recharge purposes. We conduct historical (1975-2014) and future (2055-2099) simulations for 1183 flood control reservoirs worldwide with three reservoir operation schemes: a baseline operation, a MAR operation that incorporates conjunctive use, and a FIRO-MAR operation that further employs inflow forecasts. River discharge reforecasts from the Global Flood Awareness System (GloFAS) are used to inform operation policies under varying drought risk aversion levels, represented by selected forecast ensemble quantiles. Our results reveal trade-offs between groundwater recharge and non-recharge objectives, such as hydropower generation, while highlighting synergies in water supply through conjunctive management. Under perfect forecasts, FIRO-MAR can boost the global potential of rechargeable water by approximately 14% compared to MAR alone. However, operational forecast uncertainties diminish these gains variably across regions, influenced by reservoir characteristics and background climate. Notably, forecasts prove to be more valuable for risk-averse operators, though this relationship is constrained by forecast skill and reservoir-specific factors such as inflow-to-storage ratios. Our findings elucidate how operators’ risk attitudes influence the strategic use of forecasts in supporting MAR, offering crucial insights for FIRO-MAR implementations.