Market risk aversion under volatility shifts: An experimental study

Abstract

We propose an experiment to analyze the relationship between volatility regimes and investors’ behavior and explore the mechanism by which aggregated risk aversion is configured. We design a market in which the volatility of the fundamentals is controlled and exogenously manipulated. Then we analyze the participation and trading behavior of participants under different volatility states. We observe a decrease in the market risk aversion during high volatility periods. In these periods, relatively more risk-averse investors do not participate in the risky market while less risk-averse investors trade. The individual risk aversion level of agents does not change during the experiment which leads us to conclude that the changes in market risk aversion during high volatility periods are mainly due to a participation effect.