SEMINAR: The Impact of Financial and Macroeconomic Factors on Individual Risk Attitude

The impact of financial and macroeconomic factors on individual risk attitude are explored using data from the German Socio-Economic Panel (SOEP) over the period 2004 to 2009. The three survey questions whose responses are analysed are: willingness to take risk generally; willingness to take risk in financial matters; and the amount of a hypothetical lottery win that would be invested in a risky venture. The first two of these are analysed in the framework of the Panel Ordered Probit (POP) model, which respects both the ordinality and the panel structure of the data. The third is analysed using the panel hurdle interval regression (PHINTREG) model. Household members are divided into three types: heads, spouses and offspring. Overall, spouses are found to be the most risk averse of the three types, and offspring the least risk averse. A number of macroeconomic and financial indicators are included as explanatory variables, and the effects of these on risk attitude are estimated separately for the three types, while controlling for individual characteristics. Of the macroeconomic and financial factors, the most important is year-on-year German GDP growth in the previous month, which has a positive effect on willingness to take risk for all three family member types. Next in importance is the year-on-year return on the German stock market index (HDAX) in the previous month, which has a positive effect on willingness to take risk of heads and spouses, particularly in low income households. A measure of the volatility of HDAX is also included, and this appears to have the expected negative effect on risk-taking, particularly in high-income households. The hypothetical investment decision is used to model the distribution of the coefficient of relative risk aversion (CRRA) over the population. CRRA is found to depend negatively, as expected, on GDP growth and stock market return, and positively, also as expected, on stock market volatility. The significance of GDP growth and the stock index in determining risk attitude has potentially important implications to theoretical models in macroeconomics and finance, since this result casts doubt on the widely accepted assumption of the constancy (and indeed even the exogeneity) of the coefficient of risk aversion.