Do Behavioral Biases Adversely Affect the Macro-Economy?
George M. Korniotis
University of Miami
University of Miami - School of Business Administration
September 14, 2010
Review of Financial Studies, Forthcoming
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.
Number of Pages in PDF File: 72
Keywords: Risk sharing, income risk, financial markets, cognitive abilities, behavioral biases, investor sophistication
JEL Classification: E10, G11, G12
Date posted: August 11, 2008 ; Last revised: September 17, 2010