Animal Spirits: Stock Market Volatility and Risk Aversion

Using disaggregated data from a large commercial bank and a large retail insurance company, we find that daily stock market performance affects the decision-making of loan officers and demand for insurance products in a manner difficult to reconcile with rational choice theory. A one standard deviation increase in daily stock market volatility is associated with a 5.3% decrease in the probability of future default for contemporaneously approved loans, and a 6% increase in daily insurance sales. We explore a range of potential mechanisms and find the most support for stock market volatility inducing emotion-based changes in individuals’ risk aversion. ∗Chang and Wang are at the University of Southern California. Huang is at the University of International Business and Economics. We are grateful to Harry DeAngelo, Cary Frydman, Ori Heffetz, Mireille Jacobson, Lawrence Jin, George Loewenstein, Anya Samek, Joshua Schwartzstein and seminar participants at Hong Kong Polytechnic University, Hong Kong University of Science and Technology and the University of Southern California for helpful discussions and comments.