Capital Ideas Blog

Fear factor: Wall Street edition

By Robin Mordfin

From: Blog

If you asked many Americans if the only thing we have to fear is fear itself, most of us would laugh and point out that we have plenty to fear—like losing all of our money. 

In today’s slow economy, the thought of taking even moderate risks with our hard-earned money seems abundantly stupid (especially when safe options like keeping it under the mattress are available). Plus, the thought of putting our savings into the market seems not all that different from taking it to Vegas to gamble on a six-deck game of blackjack.  

Oddly enough, while we average people sweat the small stuff, like how much we are paying for a cup of coffee and a cronut, fear of not having money is not usually the reason economists offer for why individual investors stay out of the market. They have a slew of standard explanations—changes in wealth, changes in spending habits or the investor’s background—to explain why we are hanging onto our savings.

But since the 2008 crash, even those of us who have not lost money and are living in exactly the same way are hesitant to put our cash into the market when we can keep it in a nice, federally insured CD for a couple of decades.

Still, if the usual explanations don’t work, how are economists explaining why we are still hesitating to enter the market?

Luigi Zingales, Robert C. McCormack Professor of Entrepreneurship and Finance, along with Luigi Guiso of the European University Institute and Paola Sapienza of Northwestern University, set out to find the reason. They interviewed (a foreboding) 666 clients of the large Italian bank Unicredit who had substantial accounts both before and after the crash. The team asked the clients questions about the level of risk they were willing to take for an investment.

What Zingales, Guiso, and Sapienza found was a significant rise in risk aversion, but they could find no explanation for the change in attitude. Then it occurred to them that there might be a psychological explanation for the investment changes. They did what any good researchers might do when exploring fear—they started showing horror films.

For the experiment the team chose Eli Roth’s The Hostel, the 2007 winner of the Best Horror Empire Film Award. In their paper, Time Varying Risk Aversion, the researchers explain that they conducted their experiment on a random sampling of students—mostly undergraduates—who watched a gory five-minute sample of the film and were then asked the same questions about investment risk as the Unicredit clients. Unsurprisingly to the researchers, after the viewing students showed a marked increase in risk aversion similar to the one observed in the bank data.

The team concluded that the unmitigated horror of the 2008 crash and its ongoing negative effects on the economy have scared us to the point that we are unwilling to take on the same level of risk we happily indulged in before the crash.

How long this anxiety will linger in our minds, along with how the markets and the economy will compensate for this dread, is still up in the air. But it is clear that many of us have much to fear beyond fear itself.


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