Experiences, Demand for Risky Investments and Implications for Price Dynamics

Abstract

Personal experiences can impact investors' risk taking, and this channel can explain market phenomena such as time-varying risk premia, asset price bubbles or wage-price spirals.
Establishing the link from individual experiences to market outcomes is challenging, as together with the experiences several decision-relevant factors simultaneously change.

We control these factors with a laboratory experiment and investigate the role of prior experiences on subsequent investments without confounds.

We observe that high (low) previously experienced outcomes lead to more (less) investments in a risky asset, even in a condition where experiences do not provide new information and should be ignored.

A reinforcement learning model captures the observed individual behavior and allows to investigate market price dynamics.

The experience-risk taking mechanism informs behavioral theories of markets and provides a cognitive explanation for trend-following and self-enforcing market dynamics.

Policy implications for experiences affecting investors' expectations and decisions beyond rational belief updating are discussed.

Keywords: Risk Taking, Belief Formation, Market Cycles, Return Expectations, Reinforcement Learning, Asset Price Dynamics, Decisions from Experience