Can Security Design Foster Household Risk-Taking?
56 Pages Posted: 2 Nov 2019 Last revised: 25 Jun 2020
Date Written: June 23, 2020
This paper shows that securities with a non-linear payoff design can foster household risk-taking. We demonstrate this effect empirically by exploiting the introduction of capital guarantee products in Sweden from 2002 to 2007. The fast and broad adoption of these products is associated with an increase in expected financial portfolio returns, which is especially strong for households with a low risk appetite ex ante. We explore possible economic explanations by developing a life-cycle model of consumption-portfolio decisions. The capital guarantee substantially increases risk-taking by households with pessimistic beliefs or preferences combining loss aversion and narrow framing. The welfare gains from financial innovation are stronger for households that are less willing to take risk ex ante. Our results illustrate how security design can mitigate behavioral biases and enhance economic well-being.
Keywords: Financial innovation, household finance, capital protected investment, behavioral biases, stock market participation, risk-taking
JEL Classification: I22, G1, D18, D12
Suggested Citation: Suggested Citation