Luigi Guiso on Portfolio Risk, Diversification and Trade-offs Between Individual Choice and Advice.
Daniele Fano, Head of Economic Research at Pioneer Global Asset Management and Editor of Trends in Savings and Wealth, interviews Luigi Guiso, Professor of Economics and Finance at the European University Institute in Florence who is just back from a two-year visit at the University of Chicago Graduate School of Business, on features affecting individuals’ risky portfolios. Luigi addresses a variety of issues related to individual choice such as the extent and quality of portfolio diversification also opportunities to rely on professional advice, the pros and cons of default solutions, and finally ways of dealing with principal-agent issues, such as through asset managers rating.
Daniele Fano: Thanks Luigi for accepting this interview for Trends in Savings and Wealth. We recently interviewed André Masson and Luc Arrondel on how they have approached risk in the design and interpretation of the French Survey on Household Finance.
Let me get immediately to the heart of the issue. From their point of view, there is a strong relationship between the way people address risk in the financial world, and the way people address risk in general. What is your opinion?
Luigi Guiso: Let me say first of all that the traditional idea in economics is that an individual’s attitude towards risk can be characterized by a single parameter known as the degree of risk aversion, which is identified (in technical terms) with the curvature of his utility function with respect to his wealth. One interesting piece of empirical evidence is that individuals attitude towards risk is context specific, in the sense that it depends on the particular situation at hand and how a person feels relative to that situation. An individual typically faces different types of risks but can value these risks in very different ways. So, for instance, one may show relatively low concern with respect to, say, health risk, but be very concerned about labor income risk.
These differences in attitudes may also affect the ways people address financial risks.
Daniele Fano: This is a very interesting point. Would this also imply that the same individuals interviewed at different times may give different answers depending on the risk context?
Luigi Guiso: They could indeed! We know that there is a relationship between willingness to bear risk and the particular situation one is facing. For instance, we know that individuals that are facing illness are less prompt to take other risks such as financial risks . Experimental evidence shows that one’s willingness to take a bet, even a fair one, depends on how uncertain is initial wealth, so for sure willingness to bear risk is situation dependent. To request a copy of this paper click here
| To request a copy of this paper click here |