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New paper studying risk perception in markets

posted Sep 16, 2019, 3:49 AM by Graz FinanceResearch   [ updated Sep 29, 2019, 11:58 PM by Stefan Palan ]
Cover, Journal of Banking and Finance
What do investors perceive as being risky? And if what they perceive as being risky differs from what finance theory suggests constitues risk - does the market eliminate any potential biases from individual risk perceptions? These are the core questions pursued by platform member Stefan Palan in a joint paper with Jürgen Huber and Stefan Zeisberger. Their research was recently 
published (online first) in the Journal of Banking and Finance. Titled "Does Investor Risk Perception Drive Asset Prices in Markets? Experimental Evidence", the paper finds that investors nearly exclusively focus on an asset's probabilty of yielding negative returns. In other words, risk perception is driven by the probability of losses, while for example the size of the potential losses does not seem to receive investors' attention.

While this result confirms prior research by some of the authors, finance theorists would rely on a market to eliminate any individual biases, yielding efficient prices, which properly reflect more comprehensive risk measures. Yet the paper's most important finding is precisely that this mechanism does not work. The results show that real-money experimental asset market prices fully reflect the individual risk perceptions. Assets with a higher probability of negative returns fetch lower prices in the market and vice versa. This has important implications for markets outside of the lab, for individual investors, and for investment advisors, who should account for this bias.

Huber, J., Palan, S., Zeisberger, S., Forthcoming. Does Investor Risk Perception Drive Asset Prices in Markets? Experimental Evidence, Journal of Banking & Finance 108(105635)., DOI 10.1016/j.jbankfin.2019.105635.

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