Tail Events, Emotions and Risk Taking

93 Pages Posted: 15 Jun 2020

See all articles by Brice Corgnet

Brice Corgnet

University of Saint Etienne - Analysis Group and Economic Theory Lyon St-Etienne (GATE-LSE)

Camille Cornand

Groupe d'Analyse et de Théorie Economique (GATE), CNRS, University of Lyon

Nobuyuki Hanaki

Osaka University - Institute of Social and Economic Research

Date Written: May 20, 2020

Abstract

Recent works have shown how tail events could account for financial anomalies such as the equity premiumpuzzle. These models do not explore, however, why investors would discount tail risk so heavily. We take on this challenge by designing a novel tail-event experiment to assess both investors’ behavioral and physiological reactions. We show that investors who observe the tail event without suffering losses tend to decrease their pricing of the asset subsequently. By contrast, loss-averse investors who suffer tail losses tend to increase their bids. This response is especially pronounced for those who exhibit a strong emotional response to tail losses. This demonstrates the key role played by emotions in influencing investors’ response to tail events. Finally, investors who exhibit high anticipatory arousal, as measured with electrodermal activity, posted lower bids and were less likely to suffer tail losses and go bankrupt. They also achieved higher earnings when tail events occurred frequently. This finding contrasts with the common view that investors should silence their emotions.

Keywords: tail events, emotions and risk

JEL Classification: C91, G41, D87, D91

Suggested Citation

Corgnet, Brice and Cornand, Camille and Hanaki, Nobuyuki, Tail Events, Emotions and Risk Taking (May 20, 2020). Available at SSRN: https://ssrn.com/abstract=3606079 or http://dx.doi.org/10.2139/ssrn.3606079

Brice Corgnet (Contact Author)

University of Saint Etienne - Analysis Group and Economic Theory Lyon St-Etienne (GATE-LSE) ( email )

Lyon
France

Camille Cornand

Groupe d'Analyse et de Théorie Economique (GATE), CNRS, University of Lyon ( email )

93 Chemin des Mouilles
Ecully, 69130
France

Nobuyuki Hanaki

Osaka University - Institute of Social and Economic Research ( email )

6-1, Mihogaoka
Suita, Osaka 567-0047
Japan

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