Subjective Risk-Return Trade-off

Abstract

We survey 2,548 representative U.S. respondents to estimate subjective risk-return trade-offs across savings, government bonds, stocks, real estate, gold, and cryptocurrencies. We document robust negative relationships between perceptions of risk and return among risky assets, which are observed even among financially literate respondents. Strong asset-specific sentiments, reflected in large deviations of return perceptions from average perceptions, drive these significant negative risk-return trade-offs. Both strong optimism and pessimism contribute to negative risk-return trade-offs with similar magnitudes. These negative risk-return trade-offs translate into under-diversified portfolios, as investors avoid assets they perceive to generate low returns and high risk.

Keywords: subjective risk-return trade-offs, Risk perception, Portfolio choices, Portfolio diversification

JEL Classification: G11, G12, G50, G51, D81