How Do Investors Judge the Risk of Financial Items?

41 Pages Posted: 20 Oct 2003

See all articles by Lisa Koonce

Lisa Koonce

University of Texas

Mary Lea McAnally

Texas A&M University - Department of Accounting

Molly Mercer

DePaul University

Date Written: February 4, 2004

Abstract

This paper proposes and tests a new risk model that explains how investors perceive financial risks. The model combines conventional decision theory variables - probabilities and outcomes - with variables from psychology research by Slovic (1987). The latter includes variables such as the extent to which a risky item is new, causes worry, and is controllable. To test our model, we conduct two studies in which financial statement users judge the risk of a broad range of financial items. Our results indicate that both decision theory and Slovic variables are important in explaining investors' risk judgments. Further, we demonstrate that loss outcome information contained in mandated risk disclosures not only directly influences investors' risk judgments but also indirectly affects such judgments via its effect on select Slovic variables. These results provide new theoretical insights that should be useful to accounting and psychology researchers studying how people judge risk. Our results also imply that to fully understand the effects of current and future accounting risk disclosures, managers and regulators must consider the effects of these disclosures on decision theory and Slovic variables.

Keywords: risk perception, risk disclosure, decision theory, psychology

JEL Classification: M41, M44, G12

Suggested Citation

Koonce, Lisa L. and McAnally, Mary Lea and Mercer, Molly, How Do Investors Judge the Risk of Financial Items? (February 4, 2004). Available at SSRN: https://ssrn.com/abstract=438281 or http://dx.doi.org/10.2139/ssrn.438281

Lisa L. Koonce

University of Texas ( email )

Dept. of Accounting
McCombs School of Business
Austin, TX 78712
United States
512-471-5576 (Phone)
512-471-3904 (Fax)

Mary Lea McAnally

Texas A&M University - Department of Accounting ( email )

430 Wehner
College Station, TX 77843-4353
United States
979-845-5017 (Phone)
979-845-0014 (Fax)

Molly Mercer (Contact Author)

DePaul University ( email )

1 E Jackson Blvd Suite 6000
Chicago, IL 60604
United States
(312)362-8956 (Phone)

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