What Determines Risk Tolerance?

26 Pages Posted: 11 Feb 2014 Last revised: 12 Jun 2014

See all articles by Michael Guillemette

Michael Guillemette

Texas Tech University - Department of Personal Financial Planning

David Nanigian

San Diego State University - Fowler College of Business - Finance Department

Date Written: March 31, 2014

Abstract

It is important for financial planners to understand what drives risk tolerance as it directly influences the portfolio allocation preference of clients. Possible explanations for determinants of risk tolerance include habit formation, loss aversion and investor sentiment. We hypothesize that these three factors account for significant variation in risk tolerance. We analyze average monthly scores from a widely used risk tolerance questionnaire that spans the global financial crisis (January 2003 - December 2010). We find that the habit formation, loss aversion, and sentiment proxies account for -1.06%, 38.51% and 13.21% of the variation in average monthly risk tolerance, respectively. Habit formation did not account for additional variation in average monthly risk tolerance when controlling for loss aversion and sentiment. Implications for financial planners are discussed.

Keywords: risk tolerance, risk aversion, loss aversion, habit formation, sentiment

JEL Classification: D81

Suggested Citation

Guillemette, Michael and Nanigian, David, What Determines Risk Tolerance? (March 31, 2014). Financial Services Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2393562 or http://dx.doi.org/10.2139/ssrn.2393562

Michael Guillemette (Contact Author)

Texas Tech University - Department of Personal Financial Planning ( email )

1301 Akron Ave, HS-260
Box 41210
Lubbock, TX 79409-1210
United States

David Nanigian

San Diego State University - Fowler College of Business - Finance Department ( email )

5500 Campanile Drive
San Diego, CA 92182-8236
United States
213-545-1036 (Phone)

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