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Low Interest Rates and Investor Behavior: A Behavioral Perspective Chen Lian Yueran Ma MIT Chicago Booth Boston Fed Economic Conference Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 1 / 32 How do low

  1. Low Interest Rates and Investor Behavior: A Behavioral Perspective Chen Lian Yueran Ma MIT Chicago Booth Boston Fed Economic Conference Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 1 / 32

  2. How do low interest rates affect investor behavior? Low interest rates ⇒ higher appetite for risk taking? ◮ “Reaching for yield” ; “risk-taking channel” of monetary policy Why might investors reach for yield? Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 2 / 32

  3. Why Reach for Yield? Institutional Frictions Agency problems; funding conditions of intermediaries; etc ◮ Theories: Diamond-Rajan 12; Morris-Shin 14; Acharya-Naqvi 15; Drechsler-Savov-Schnabl 17 ◮ Empirics: Maddaloni-Peydro 11; Jimenez et al 14; Chodorow-Reich 14; Hanson-Stein 15 Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 3 / 32

  4. Why Reach for Yield? Behavioral Perspective Intrinsic individual-level tendencies; preferences & psychology ◮ How investors perceive and evaluate return and risk trade-offs ◮ Savers & the “risk-taking channel” of monetary policy Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 4 / 32

  5. A Simple Experiment Fix principal. Randomly assign to: Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 5 / 32

  6. A Simple Experiment Fix principal. Randomly assign to: Case 1: ◮ Safe asset: 5% interest rate. ◮ Risky asset: 10% average returns; approx. normal 18% vol. Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 5 / 32

  7. A Simple Experiment Fix principal. Randomly assign to: Case 2: ◮ Safe asset: 1% interest rate. ◮ Risky asset: 6% average returns; approx. normal 18% vol. Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 5 / 32

  8. A Simple Experiment Fix principal. Randomly assign to: Case 1: ◮ Safe asset: 5% interest rate. ◮ Risky asset: 10% average returns; approx. normal 18% vol. Case 2: ◮ Safe asset: 1% interest rate. ◮ Risky asset: 6% average returns; approx. normal 18% vol. Fix Sharpe ratio of risky asset, lower the interest rate. Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 5 / 32

  9. A Simple Experiment Fix principal. Randomly assign to: Case 1: ◮ Safe asset: 5% interest rate. ◮ Risky asset: 10% average returns; approx. normal 18% vol. Case 2: ◮ Safe asset: 1% interest rate. ◮ Risky asset: 6% average returns; approx. normal 18% vol. Fix Sharpe ratio of risky asset, lower the interest rate. Allocations to the risky asset significantly higher in Case 2. Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 5 / 32

  10. Preview 80 Mean Allocations in Risky Asset (%) 75 70 65 60 55 50 -1 0 1 3 5 10 15 Risk-Free Rate (%) Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 6 / 32

  11. Preview 80 Mean Allocations in Risky Asset (%) 75 70 65 60 55 50 -1 0 1 3 5 10 15 Risk-Free Rate (%) Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 6 / 32

  12. Outline 1 Reaching for Yield in Individual Investment Decisions ◮ Randomized experiments (US households, HBS MBAs, Netherlands) ◮ Observational data on household investment allocations 2 Mechanisms ◮ #1: Reference dependence ◮ #2: Salience and proportional thinking ◮ Nominal vs. real interest rates 3 Implications ◮ Savers in a low interest rate world ◮ Financial institutions ◮ Asset prices & capital markets Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 7 / 32

  13. Outline 1 Reaching for Yield in Individual Investment Decisions ◮ Randomized experiments (US households, HBS MBAs, Netherlands) ◮ Observational data on household investment allocations 2 Mechanisms ◮ #1: Reference dependence ◮ #2: Salience and proportional thinking ◮ Nominal vs. real interest rates 3 Implications ◮ Savers in a low interest rate world ◮ Financial institutions ◮ Asset prices & capital markets Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 7 / 32

  14. Benchmark Experiment Two conditions with 200 people in each condition. ◮ High interest rate condition: 5%—10%. ◮ Low interest rate condition: 1%—6%. Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 8 / 32

  15. Benchmark Experiment Two conditions with 200 people in each condition. ◮ High interest rate condition: 5%—10%. ◮ Low interest rate condition: 1%—6%. 1 MTurk, Hypothetical ◮ Consider allocating total savings of $100,000 2 MTurk, Incentivized ◮ Invest experimental endowment of 100,000 Francs ◮ Receive bonus payment in dollars, proportional to investment payoff ◮ On the scale of $12, paid to 10% randomly selected participants 3 HBS MBA, Incentivized ◮ Invest experimental endowment of 1,000,000 Francs ◮ Receive bonus payment in dollars, proportional to investment payoff ◮ On the scale of $200, paid to 10% randomly selected participants Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 8 / 32

  16. Geographic Distribution: MTurk Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 9 / 32

  17. Demographics: MTurk Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 10 / 32

  18. Demographics: HBS MBAs Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 11 / 32

  19. Demographics: HBS MBAs Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 12 / 32

  20. Benchmark Experiment Mean Allocations to Risky Asset (%) High: 5—10 Low: 1—6 Dif [ t ] MTurk, Hypo. 48.15 55.32 7.17 [2.52] MTurk, Incen. 58.58 66.64 8.06 [3.06] HBS MBA, Incen. 66.79 75.61 8.83 [3.13] Similar results across different settings and populations ◮ Do not diminish with education, wealth, investment experience Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 13 / 32

  21. More Interest Rate Conditions Fix excess returns (mean 5%), change r f . 200 people per condition. 80 77.6 Mean Allocations in Risky Asset (%) 75 69.7 70 64.6 65 60 58.3 56.8 55 50.6 49.9 50 -1 0 1 3 5 10 15 Risk-Free Rate (%) Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 14 / 32

  22. Replication by Dutch Authority for Financial Markets Om meer inzicht te krijgen in risicobereidheid van Nederlandse con- sumenten bij een lage of zelfs negatieve spaarrente, repliceerden we in het AFM Consument Panel onderzoek van Chen Lian en Yueran Ma en Carmen Wang “Low Interest Rates and Risk Taking: Evidence from Individual Investment Decisions.” Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 15 / 32

  23. More Interest Rate Conditions Fix excess returns (mean 5%), change r f . US & Dutch. 80 77.6 Mean Allocations in Risky Asset (%) 71.6 69.7 70 64.6 60 58.3 56.8 56.1 50.6 49.9 50 49.1 42.4 40 38.9 33.3 30 -1 0 1 3 5 10 15 Risk-Free Rate (%) US (Incentivized, MTurk) NL (Hypothetical, AFM Panel) Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 16 / 32

  24. Observational Data 1 American Association of Individual Investors (AAII) ◮ Members report percentage of portfolio allocations to ⋆ Stocks (directly held & mutual fund) ⋆ Cash (interest-bearing safe assets) 2 Mutual Fund Flows ◮ Flows into equity and high yield corporate bond mutual funds 3 Flow of Funds ◮ Household sector flows into stocks and interest-bearing safe assets 4 Structured Financial Products (Celerier-Vallee 17) ◮ Low interest rates ⇒ attractiveness of structured financial products ◮ Europe, Asia Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 17 / 32

  25. AAII: Allocation to Stock Mean Allocations to Stocks (1) (2) (3) (4) L. r f -0.38 -1.47 -1.92 -2.00 [-0.51] [-4.49] [-2.46] [-2.57] L.P/E10 0.84 [9.16] L. Surp 6.79 [0.40] L. E [ rx 12 stk ] -0.12 [-0.60] L.AAII Sentiment 0.04 0.17 0.16 [1.66] [4.01] [3.67] L. VIX 2 -6.34 -14.45 -5.73 [-0.78] [-0.96] [-0.27] L.Past 12M GDP Growth 0.34 2.11 2.17 [0.85] [2.61] [2.77] L.Credit Spread -3.87 -2.64 -3.37 [-4.02] [-1.34] [-1.46] Constant 61.47 52.58 66.01 68.87 [19.30] [14.59] [10.88] [9.03] Observations 326 326 326 326 Newey-West t -statistics in brackets Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 18 / 32

  26. AAII Allocations Response to Innovations in Short Rate (sVAR) 30 0 20 -10 -20 10 -30 0 0 2 4 6 0 2 4 6 Months Months 95% CI cumulative irf 95% CI cumulative irf Stocks Cash Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 19 / 32

  27. Household Investment Flows 4 0 2 -1 0 -2 -2 -3 -4 0 2 4 6 0 2 4 6 Months Months Equity MF (ICI) HY Corp Bond MF (ICI) 0 3 -1 2 -2 1 -3 -4 0 0 2 4 6 0 2 4 6 Quarters Quarters Stocks (FoF) Deposits (FoF) Who is on the other side? Foreign investors. Corporate issuers. Yueran Ma (Chicago Booth) Low Interest Rates: Behavioral Perspective September 2018 20 / 32

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