Investment Decisions and Negative Interest Rates 
While deposit rates and government bonds yields are typically different across different countries, the current discrepancy is unusual because in several prominent economies, mainly in Europe, the deposit rates and government bond yields are negative and in others, such as in the United States, the corresponding rates are positive. Insights from Prospect Theory indicating loss-aversion, risk-seeking in the loss domain, and risk-aversion in the gain domain together suggest that having negative rates in Europe and positive rates in the United States may lead to an excess flow of funds into the United States. Yet the insights of Prospect Theory and subsequent literature rely on tasks that are fundamentally different from an investment decision under negative interest rates. Specifically, investment decisions are made based on rates of return rather than absolute amounts, and the task is a fund-allocation task rather than a choice or a pricing task as used in the literature. Moreover, parking money in the United States as a foreign investor may lead, due to exchange rate risk, to a mixed lottery, while the literature mostly studies non-mixed lotteries. Hence, to gain insights into how foreign investors may act in light of negative rates, the author explores investors' behavior in a mixed-return lottery, using a series of lab experiments, where the task is to allocate money between two portfolios with either a sure return or a risky return.
Key Findings
- The author finds no framing effect on investment, meaning that the average investment share in the risky portfolio (lottery) is similar across the gain and the loss domains.
- No evidence is found of risk-seeking in the loss domain or in the gain domain, and the behavior is mostly risk-neutral.
- These results hold for a large range of stakes, no matter whether the money to invest is literally on the table, regardless of the language used to describe the problem (abstract or not), and regardless of whether the lottery is a two-state or a three-state lottery. Furthermore, the results are not driven by the task being continuous rather than discrete or because the risky portfolio is a mixed lottery.
Implications
The implication of this result is that investors may not overreact to discrepancies in rates just because some rates are negative and others are positive. The study also contributes more generally to the literature by providing an example of a decision in which attitudes toward risk do not follow the pattern suggested by Prospect Theory and adds to the growing evidence that attitudes towards risk are sensitive to the decision environment.
Abstract
While the current European Central Bank deposit rate and 2-year German government bond yields are negative, the U.S. 2-year government bond and deposit rates are positive. Insights from Prospect Theory suggest that this situation may lead to an excess flow of funds into the United States. Yet the environment of negative interest rates is different from the environment considered in Prospect Theory and subsequent literature, since decisions are framed in terms of rates of return rather than absolute amounts and the task involves the allocation of funds rather than a choice or a pricing task as is often used in the literature. Moreover, parking money in the United States as a foreign investor may lead to a mixed lottery due to exchange rate risk, while the literature mostly studies non-mixed lotteries. We therefore explore investors' behavior in a mixed-return lottery, using a series of lab experiments where the task is to allocate money between two portfolios with either a sure return or a risky return. We use a between-subject design such that, while the investment decisions are the same, those in the negative frame allocate funds between a sure negative return and a lottery, and those in the positive frame allocate funds between a sure positive return and a lottery. Surprisingly, we find no framing effect on investment, a result that holds for a large range of stakes, no matter whether the money to invest is literally on the table, regardless of the language used to describe the problem (abstract or not), and no matter whether the lottery is a two-state or a three-state lottery. We find that this result is not driven by whether the task is continuous rather than discrete or because the risky portfolio is a mixed lottery. Not only do we find no effect of the frame on the investment decision, we also find no evidence of risk-seeking in the loss domain, and that the behavior is mostly risk-neutral.