Do Behavioral Biases Adversely Affect the Macro-Economy?

Review of Financial Studies, Forthcoming

72 Pages Posted: 11 Aug 2008 Last revised: 17 Sep 2010

George M. Korniotis

University of Miami

Alok Kumar

University of Miami - School of Business Administration

Date Written: September 14, 2010

Abstract

We investigate whether the adverse effects of investors’ behavioral biases extend beyond the domain of financial markets to the broad macro-economy. Focusing on the income risk-sharing role of financial markets, we find that risk-sharing is higher (more than double) in U.S. states where investors are more sophisticated and exhibit weaker behavioral biases. The potential for risk-sharing varies geographically but states with better risk-sharing opportunities are able to achieve higher levels of risk sharing only when investors in those states are more sophisticated. Collectively, these results indicate that investors’ aggregate behavioral biases and their lack of financial sophistication adversely affect the local macroeconomy.

Keywords: Risk sharing, income risk, financial markets, cognitive abilities, behavioral biases, investor sophistication

JEL Classification: E10, G11, G12

Suggested Citation

Korniotis, George M. and Kumar, Alok, Do Behavioral Biases Adversely Affect the Macro-Economy? (September 14, 2010). Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1216163 or http://dx.doi.org/10.2139/ssrn.1216163

George M. Korniotis

University of Miami ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
305-284-5728 (Phone)

Alok Kumar (Contact Author)

University of Miami - School of Business Administration ( email )

514 Jenkins Building
Department of Finance
Coral Gables, FL 33124-6552
United States
305-284-1882 (Phone)

HOME PAGE: http://moya.bus.miami.edu/~akumar

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