Preferred Risk Habitat of Individual Investors
Coauthor(s): Daniel Dorn.
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The preferred risk habitat hypothesis, introduced here, is that individual investors select stocks whose volatilities are commensurate with their risk aversion. The data, 1995-2000 holdings of over 20,000 clients at a large German broker, are consistent with the predictions of the hypothesis: the portfolios contain highly
similar stocks in terms of volatility, when stocks are sold they are replaced by stocks of similar volatilities, and the more risk averse customers indeed hold and trade into less volatile stocks. Greater volatility specialization is associated with lower Sharpe ratios, primarily because more specialized investors hold fewer stocks
and thereby expose themselves to more unsystematic risk.
Source: Working Paper
Dorn, Daniel, and Gur Huberman. "Preferred Risk Habitat of Individual Investors." Working Paper, Columbia University, March 2009.