Stock market expectations and risk aversion of individual investors

- We study the joint effects of stock market return expectations and risk aversion of individuals on investment decisions.
- Higher risk aversion is associated with lower stock market expectations.
- Probability of investing in stocks is positively related to expected market return and negatively to risk aversion.
- High risk aversion moderates the positive impact of stock market expectations on the stock market participation.
- Once individuals invest in stocks, their stock market expectations alone determine their portfolio allocation.

We study the relationship between stock market return expectations and risk aversion of individuals and test whether the joint effects arising from the interaction of these two variables affect investment decisions. Using data from the Dutch National Bank Household Survey, we find that higher risk aversion is associated with lower stock market expectations. We identify significant and negative effects on the probability that individuals invest in stocks arising from the interaction between stock market expectations and risk aversion. These effects are in addition to a significant and positive impact from stock market return expectations as well as a significant and negative effect from risk aversion separately. However, once individuals participate in the stock market, their stock market expectations alone remain significant in determining their portfolio allocation decisions.