Chapter 18: Risk Perception and Risk Tolerance
Investor Behavior: The Psychology of Financial Planning and Investing. H. Kent Baker and Victor Ricciardi, editors, 327-345, Hoboken, NJ: John Wiley & Sons, Inc. , 2014.
Posted: 20 Jan 2014 Last revised: 10 May 2014
Date Written: February 8, 2014
This chapter provides an overview of the research literature and the important issues regarding risk perception and risk tolerance. The academic literature reveals that various disciplines provide an assortment of perspectives in terms of how to define, describe, and analyze risk. The behavioral finance perspective encompasses the subjective and objective factors of risk within the domains of risk perception and risk tolerance. Risk perception is the subjective decision-making process that an investor uses when evaluating risk and the amount of uncertainty. Risk tolerance is the degree of risk that an investor is willing to endure in the pursuit of a financial objective. A major problem within the risk tolerance literature is the lack of general agreement about issues such as a standard definition, a uniform theory or model, measurement discrepancies, and the growing number of questionnaires. Academic researchers and practitioners are only now starting to study and understand the long-term effects of the financial crisis in 2007 and 2008 on investor risk-taking behavior.
Keywords: Risk, risk tolerance, uncertainty, objective risk, subjective risk, risk perception, perceived risk, risk-taking behavior, standard finance, behavioral finance, financial psychology, modern portfolio theory, emotions, behavioural finance, behavioral economics, behavioural economics
JEL Classification: A12, D81, G00, G30, G10, M00, M10, M41
Suggested Citation: Suggested Citation