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What happens to investment choices when interest rates change? An experimental study

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  • Lahav, Yaron
  • Benzion, Uri

Abstract

We study experimentally how subjects react to changes in interest rates. Our participants were asked to divide 1,000 units of currency between two assets – one risky and the other risk-free – in four different settings. We use different treatments to change the risk-free rate while keeping the risk premium constant. We find that risk-free rates affect risk allocation asymmetrically: subjects increase the risky portion in their portfolios in response to a decrease in rates. Still, they do not change their portfolios when rates rise. Furthermore, this asymmetric effect occurs only when interest rates remain constant over a relatively long duration; when they are volatile, their impact on risk allocation is reversed. We provide and test a behavioral explanation for these findings.

Suggested Citation

  • Lahav, Yaron & Benzion, Uri, 2022. "What happens to investment choices when interest rates change? An experimental study," The Quarterly Review of Economics and Finance, Elsevier, vol. 86(C), pages 471-481.
    • Handle: RePEc:eee:quaeco:v:86:y:2022:i:c:p:471-481
    DOI: 10.1016/j.qref.2022.09.002
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    More about this item

    Keywords

    Experimental finance; Interest rate; Investment decision; Risk allocation;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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