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Anxiety in the face of risk


Abstract: We model an ?anxious? agent as one who is more risk averse with respect to imminent risks than with respect to distant risks. Based on a utility function that captures individual subjects? behavior in experiments, we provide a tractable theory relaxing the restriction of constant risk aversion across horizons and show that it generates rich implications. We first apply the model to insurance markets and explain the high premia for short-horizon insurance. Then, we show that costly delegated portfolio management, investment advice, and withdrawal fees emerge as endogenous features and strategies to cope with dynamic inconsistency in intratemporal risk-return tradeoffs.

Keywords: risk premia; insurance; term structure; dynamic inconsistency;

JEL Classification: D01; D03; D81; G02; G11; G12;

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Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2015-12-01

Number: 610