Risk tolerance in financial decision making

(editors) This book sheds light on the emotional side of risk taking behaviour and is based on an innovative cross-disciplinary approach, mixing financial competences with others, related to psychology and affective neuroscience. The book provides a deep theoretical background on the risk tolerance issue and holds the singular results of an empirical research aimed at investigating the emotional side of risk taking behaviour. In the theoretical sections, traditional and behavioural approaches are considered to study both the investment and the debt decision process of individuals and households, respectively. The fallacy of traditional measures of responsible investing and borrowing suggests the choice for the introduction of a perspective coming from psychology and affective neuroscience. The second part of the book describes our unique empirical research which involves more than 450 individuals: banks’ customers, bankers, traders and asset managers. The book proposes traditional and innovative measures of risk tolerance. The most innovative is a measure of the “unbiased risk tolerance” (UR) of individuals, which is the love or aversion to risk shown during a controlled experiment aimed at observing both the choices and the uncontrolled (somatic) responses to risky decisions. We employed a psycho-physiological test, named the Iowa Gambling Task (IGT), in order to evaluate the Skin’s Conductance Response (SCR) while making risky choices. The research compares the unbiased risk tolerance with both a measure for the biased risk tolerance (BR), obtained by a financial risk tolerance self-evaluation test and a measure of the risk tolerance shown in real-life investment/decision choices (RLR). Any difference between UR and BR shows whether individuals are able to properly self-evaluate their risk tolerance or not, over/under valuing their personal capability to afford financial risk. The comparisons among UR, BR and RLR are essential to understand what drives real-life risk taking behaviour: either who we are or who we suppose to be. Results on both the investment and debt side are provided in order to depict the demographic-socio economical and cultural reasons which could explain incoherencies among UR, BR and RLR. The book concludes with the implications involved by our results for market participants and for regulators. These implications appear even more relevant if connected to the new regulation of financial markets, introduced by MIFID, in terms of transparency and communication between intermediaries and customers