Can Security Design Foster Household Risk-Taking?
111 Pages Posted: 29 Jun 2020 Last revised: 16 Aug 2020
Date Written: June 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: behavioral biases, capital guarantee product, household finance, risk-taking, security design
JEL Classification: D12, D18, G1, I22
Suggested Citation: Suggested Citation