Investment flexibility and the acceptance of risk

The hypothesis examined in this paper is that the greater the investor's flexibility, the easier it is for him to change his portfolio depending on his results, the more willing he will be to accept risks. When the investor has no control on the size of the risky investment, but can choose between one risky and one riskless asset, this conjecture is shown to be correct. However, if there is more than one risky asset each period, counterexamples demonstrate that flexibility rarely ensures greater risk taking. For the standard portfolio problem in which investors are free to determine the size of their investment in a risky asset, flexibility always raises the demand for the risky asset if constant relative risk aversion is less than unity. But counterexamples can always be found when the constant relative risk aversion is larger than unity. (C) 1997 Academic Press.