Empirical evidence of risk aversion in the real world: Small stocks, Large stocks, Government bonds, and Treasury bills, 1926-2017

Although there may be various social contexts in which people stray from risk averse behavior (e.g., the risk loving behavior which is on display whenever people place bets on gambles with unfair odds), in other (more economically consequential settings), it does appear that risk averse behavior is more the rule rather than the exception. Indeed, risk aversion is what motivates people to buy insurance and diversify risk in their asset holdings.

The financial markets provide us with a superb example of risk averse behavior writ large. Historically, here are the long run (1926-2017) compound annual returns on stocks, bonds, and bills that are traded in U.S. financial markets (source: page 9 of http://bit.ly/sbbi2018):

Risk for these various asset classes is lowest for Treasury bills, a bit higher for Government bonds, a bit higher yet for Large stocks, and highest for Small stocks. If you are risk averse, then if one asset has higher risk than another, you are not willing to invest in the riskier asset unless you can reasonably expect that on average, you’ll be compensated for bearing the extra risk in the form of a higher expected return, and it turns out that this is exactly what happens in the real world. If investors were to act in a risk neutral fashion, then the average returns wouldn’t be all that different from each other. Finally if investors were to act in a risk loving fashion, they’d pay more for risky assets than for safe; this would cause risky assets to be bid up in value relative to safe assets, which in turn would imply lower average returns for risky than for safe assets.

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