Write a review of the article. Use finance theory to explain and critique the key points that the authors are trying to communicate.
Canner, Mankiw and Well (1997) suggest that Wall Street financial planners often recommend a different mix of financial assets for highly risk tolerant clients than for more risk averse individuals. Risk tolerant investors should buy more high risk, high expected return assets such as stocks, than low risk, low expected return assets such as bonds. As plausible as this advice may sound, it differs markedly from the behavior of the rational expected-utility-maximizing investors inhabiting the Capital Asset Pricing Model (CAPM) used in most finance and economics research. All risky assets-including both stocks and bonds-are part of the "market portfolio" in the CAPM. Increased tolerance for risk causes CAPM investors to alter the percentage of assets held in the risky portfolio as opposed to the risk-free asset, but the composition of stocks and bonds held in the risky portfolio is not changed.
This paper investigates the behavior of investors nearing retirement. More specifically, we focus on two hypotheses implicit in the CAPM:
(1) risk tolerant individuals hold a smaller proportion of risk-free assets, and
(2) the composition of an individual's portfolio of risky assets will not change as he/she becomes more risk tolerant. We examine survey data reported in the 1992 Health and Retirement Survey, concerning individuals' asset allocations and willingness to take risk as they approach retirement.
Each person's portfolio is decom¬posed into assets held as stock, bonds and Treasury Bills. Assuming that Treasury Bills are "risk-free assets" while stocks and bonds are "risky," the CAPM's predictions become (I) the proportion of all assets allocated to Treasury Bills should fall as risk tolerance increases, and (2) the proportion of risky assets allocated to stocks is independent of risk tolerance. Wall Street seems to be comfortable with the first of these predictions, but not the second. We find support for both predictions.
Attachment:- Risk tolerance and asset allocation.pdf