nr 112 - Global Risk, Investment, and Emotions

DNB Working Papers
Publicatiedatum 6 september 2006

We investigate a novel dynamic choice problem in an experiment where emotions are measured through self-reports. The choice problem concerns the investment of an amount of money in a safe option and a risky option when there is a “global risk” of losing all earnings, from both options, including any return from the risky option. Our key finding is that global risk can reduce the amount invested in the risky option. This result cannot be explained by classical Expected Utility or by its main contenders Rank-Dependent Utility and Cumulative Prospect Theory. An explanation is offered by taking account of emotions, using the emotion data from the experiment and recent psychological findings. We also find that people invest less if own earnings are at stake, compared to money obtained as an endowment. Key words: investment, global risk, real effort, emotions, dynamic choice. JEL-classification: A12, C91, D80, G11.