Can Security Design Foster Household Risk-Taking?

56 Pages Posted: 2 Nov 2019 Last revised: 25 Jun 2020

See all articles by Laurent E. Calvet

Laurent E. Calvet

EDHEC Business School - Department of Economics & Finance; CEPR

Claire Celerier

University of Toronto - Rotman School of Management

Paolo Sodini

Stockholm School of Economics - Department of Finance; Swedish House of Finance

Boris Vallee

Harvard Business School - Finance Unit

Multiple version iconThere are 2 versions of this paper

Date Written: June 23, 2020

Abstract

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

Calvet, Laurent E. and Celerier, Claire and Sodini, Paolo and Vallee, Boris, Can Security Design Foster Household Risk-Taking? (June 23, 2020). Available at SSRN: https://ssrn.com/abstract=3474645 or http://dx.doi.org/10.2139/ssrn.3474645

Laurent E. Calvet

EDHEC Business School - Department of Economics & Finance ( email )

France

CEPR ( email )

33 Great Sutton Street
London, EC1V 0DX
United Kingdom

Claire Celerier (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Paolo Sodini

Stockholm School of Economics - Department of Finance ( email )

Sveavagen 65, Box 6501
SE-113 83 Stockholm
Sweden
46 8 7369165 (Phone)
46 8 312327 (Fax)

HOME PAGE: http://www.hhs.se/secfi/People/Faculty/Finpso/finp

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Boris Vallee

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States

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