TY  - JOUR
AU  - Aizenman,Joshua
AU  - Marion,Nancy
TI  - Volatility, Investment and Disappointment Aversion
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 5386
PY  - 1995
Y2  - December 1995
UR  - http://www.nber.org/papers/w5386
L1  - http://www.nber.org/papers/w5386.pdf
N1  - Author contact info:
Joshua Aizenman
Economics and SIR
USC
University Park
Los Angeles, CA 90089-0043
Tel: 213-740-4066
E-Mail: aizenman@usc.edu

Nancy Marion
Department of Economics
Dartmouth College
Hanover, NH  03755
E-Mail: Nancy.P.Marion@Dartmouth.EDU
AB  - This study uncovers a statistically significant negative correlation between volatility and private investment over the 1970-93 period in a set of almost fifty developing countries and provides a possible interpretation of this result by using the disappointment- aversion expected utility framework first described by Gul (1991).  We consider a number of different volatility measures related to domestic policies or to external factors.  As the various volatility measures tend to be positively correlated, we do not claim to identify a unique measure as the dominant source of volatility.  Instead, we demonstrate that for a number of different measures, volatility reduces private investment in developing countries.  We then show that the disappointment-aversion framework provides a useful way of illustrating the adverse first-order effects of volatility.  When agents are disappointment-averse, they put more weight on 'bad' outcomes and less weight on 'good' outcomes than in the standard case. The asymmetric weighting of outcomes introduces additional concavity into the utility function and causes volatility to have significant, negative effects on economic performance.  The large, negative effects of increased volatility continue to hold even if the coefficient of relative risk aversion approaches zero (that is, even if the marginal utility of income is constant so that agents are risk neutral in the conventional sense).
ER  -