Anxiety in the Face of Risk
35 Pages Posted: 3 Apr 2013 Last revised: 28 Oct 2015
Date Written: October 27, 2015
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.
Keywords: risk premia, insurance, term structure, dynamic inconsistency
JEL Classification: D01, D03, D81, G02, G11, G12
Suggested Citation: Suggested Citation