Question

b) The risk appetite and risk awareness of investors/organizations may change according to the business environment. Analyze the factors that may affect the change of risk aversion in investors/organizations. Relevant examples or illustration should be given.

Answer 1

Factors that can effect risk aversion:

• A poorer outlook for economy can raise the risk aversion because investors react to increased likelihood of low wealth situations by reducing willingness to bear risk.
• Rising risk in equity & credit market makes it likely that future wealth can be lower & hence can lead to high risk aversion.
• Declines in major equity markets can also explain the movements in risk aversion. Especially US stock market which is the key source of negative information for German equity investors. The negative information from the US stock market can be measured by means of interaction dummy set to unity for negative S&P 500 returns.

All these things can be explained by regression approach. Thus in our regression model we can evaluate how a change in for example, the slope of term structure changes the risk aversion indicator. The estimation helps in mitigating any bias caused by differences between statistical & preference weighted PDF that are not related to risk aversion.

Many internal & external factors correlate with whether one is risk averse or not. If one’s preference change and if so in what direction. Factors like gender, education, race, ethnicity, depression etc. are most important factors that interact with one risk’s preferences over a period of time.

These factors are important and has to be kept in one’s mind when planning how best to invest in the financial assets.