An incentive problem of risk balancing in portfolio choices

• This article analyzes the incentives of risk balancing for stock investors.
• Examine how investors adjust the asset shares in their portfolios in response to potential risks.
• Investors reduce the weight of stock they hold to offset the impacts of potential risks.
• Investors have a desire to reduce the weight of stock dramatically, given some scenarios.

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.