Anxiety in the Face of Risk - Federal Reserve Bank of New York

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Anxiety in the Face of Risk

April 2013 Number 610
Revised December 2015

JEL classification: D01, D03, D81, G02, G11, G12

Authors: Thomas M. Eisenbach and Martin C. Schmalz

We model an “anxious” agent as one who is more risk averse with respect to imminent risks than with respect to distant risks. Based on a utility function that captures individual subjects’ behavior in experiments, we provide a tractable theory relaxing the restriction of constant risk aversion across horizons and show that it generates rich implications. We first apply the model to insurance markets and explain the high premia for short-horizon insurance. Then, we show that costly delegated portfolio management, investment advice, and withdrawal fees emerge as endogenous features and strategies to cope with dynamic inconsistency in intratemporal risk-return tradeoffs.

Available only in PDF pdf

36 pages / 621 kb

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