Money demand and risk: A classroom experiment

The authors describe a classroom experiment that motivates student understanding of behavior toward risk and its effect on money demand. In this experiment, students are endowed with an income stream that they can allocate between a risk-free fund and a risky fund. Changes in volatility are represented by mean-preserving changes in the variance of the risky fund. When volatility of the risky fund increases, reallocating to the risk-free fund results in an increase in aggregate money demand. By responding to changes in volatility and then observing the aggregate response of their cohort, students gain a better understanding of the concept of money demand, portfolio allocation, and risk.