The Psychology of Risk: The Behavioral Finance Perspective

Abstract

Since the mid-1970s, hundreds of academic studies have been conducted in risk perception-oriented research within the social sciences (e.g., nonfinancial areas) across various branches of learning. The academic foundation pertaining to the "psychological aspects" of risk perception studies in behavioral finance, accounting, and economics developed from the earlier works on risky behaviors and hazardous activities. This research on risky and hazardous situations was based on studies performed at Decision Research (an organization founded in 1976 by Paul Slovic) on risk perception documenting specific behavioral risk characteristics from psychology that can be applied within a financial and investment decision-making context. A notable theme within the risk perception literature is how an investor processes information and the various behavioral finance theories and issues that might influence a person's perception of risk within the judgment process. The different behavioral finance theories and concepts that influence an individual's perception of risk for different types of financial services and investment products are heuristics, overconfidence, prospect theory, loss aversion, representativeness, framing, anchoring, familiarity bias, perceived control, expert knowledge, affect (feelings), and worry.

Keywords: risk, perception, risk perception, perceived risk, judgment, decision making, behavioral decision theory (BDT) , behavioral accounting, standard finance, behavioral finance, behavioral economics, psychology, efficient market hypothesis, rationality, bounded rationality, classical decision theory

JEL Classification: A12, D81, G00, G30, G10, M00, M10, M41