An incentive problem of risk balancing in portfolio choices

This study provides a new perspective on the incentive of risk balancing by examining how investors adjust their portfolio weights in response to changes in volatility risk, market risk, and liquidity risk. We find that investors have motives to mitigate the disproportionate impacts of these potential risks. Investors significantly reduce the weight of stock they hold, as opposed to increasing the weight of stock, to offset the impacts of the three potential risks, even though one risk has diversification benefits, while other risks generate adverse impacts. Moreover, we conclude that investors have a desire to greatly reduce the weight of stock, given some scenarios of a lower-growth stock, a higher asset correlation, a more risk-averse investor, and a greater intensity of crisis events. (C) 2016 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.