The influence of endogenous and exogenous factors on investor risk-tolerance behaviour

PhD (Risk Management), North-West University, Vanderbijlpark Campus, 2021Individual investors expect investment companies to construct, measure and evaluate strategies that will assist them to make successful investment decisions. Financial planners are operating in an environment where it is prudent and legally required to be acquainted with their clients’ financial, attitudinal and emotional circumstances before making recommendations regarding investment decisions. Risk assessment forms, which are constructed based on institutional intellect regarding rational investor behaviour, are utilised by financial planners to measure the risk tolerance of individual investors. However, a lack of regulatory guidance on risk profiling in the financial industry resulted in a diverse approach to risk profiling evaluations. Consequently, existing and conventional risk assessment forms used by practitioners in the financial industry have major shortcomings, as it is not comprehensive enough to consider all the factors that may affect the risk tolerance behaviour of individual investors when making investment decisions. Therefore, existing and conventional risk assessment forms can be improved by recommending a framework that makes provision for client-specific questions by considering a multitude of pre-identified endogenous and exogenous factors that influence investor risk tolerance behaviour. For this reason, the primary objective of this research study was to construct a model to profile investor risk tolerance behaviour based on endogenous and exogenous factors to improve existing and conventional risk assessment forms and accordingly, to profile the risk tolerance behaviour of individual investors more accurately and comprehensively. In order to facilitate the achievement of the primary objective, theoretical and empirical objectives were formulated. The theoretical objectives presented a thorough analysis of the theory of risk tolerance and risk behaviour and contextualised a theoretical framework about individual investment decision-making. The theoretical theories and previous studies relating to the endogenous and exogenous factors that influence the risk tolerance behaviour of individual investors when making investment decisions were also examined. It can be inferred from the theoretical objectives that individual investors, financial planners and investment companies ought to consider and comprehend the factors related to risk tolerance behaviour, as it has a momentous influence on the risk profiling and the investment decision-making of individual investors. Even though previous research studies have examined the factors related to investor risk tolerance behaviour, they have not considered the influence of a multitude of both endogenous and exogenous factors on the risk tolerance behaviour of individual investors when making investment decisions. Also, previous research studies have not addressed the shortcomings of existing and conventional risk assessment forms by considering endogenous and exogenous factors to provide a more accurate and comprehensive model to profile investor risk tolerance behaviour. This research study entailed a descriptive research design, whereby a positivist research paradigm was applied and a quantitative research approach was followed. The target population comprised individual investors from an investment company within the South African context. A non-probability purposive sampling method was used to filter the individual investors from the investment company, who met the inclusion criteria of 18 years and older, a current investor with some form of a formal investment product with the investment company and lives in Gauteng, to obtain the representative sample. The sample size of 463 individual investors was considered adequate for the analysis of the quantitative data, as it sufficiently met all the requirements for the statistical analysis applied to facilitate the attainment of the empirical objectives. The primary quantitative data were collected through a self-administered questionnaire and validated scales were utilised. It can be inferred from the empirical results that the majority of individual investors have a propensity to take average risks when making investment decisions and are in the defensive (cautious) investor phase of the life cycle rather than in the growth investor phase of the life cycle. Corresponding to the investor life cycle theory, younger individual investors with a smaller net worth are in the growth investor phase of the life cycle, while older individual investors with a greater net worth are in the defensive (cautious) investor phase of the life cycle. It was also established that the investment decisions of individual investors are driven to the greatest extent by the self-control bias and to the smallest extent by the anchoring bias. Furthermore, the investment decisions of individual investors in the growth investor phase of the life cycle are only driven by the representativeness bias and the overconfidence bias. However, the investment decisions of individual investors in the defensive (cautious) investor phase of the life cycle are driven by the representativeness bias, the overconfidence bias, the gambler’s fallacy bias, the availability bias, the loss aversion bias, the mental accounting bias and the self-control bias. Moreover, it was also confirmed that all the endogenous factors, except for the demographical factor, namely income variability, and all the exogenous factors had significant effects on individual investor risk tolerance behaviour. The successful findings of the empirical results make a remarkable contribution to the field of study and the financial industry. However, the key contribution of the research study is encompassed in the final empirical objective, the development and validation of a model to profile investor risk tolerance behaviour based on endogenous and exogenous factors, since no other researcher has developed such a model to date. Based on the structural equation modelling results, only the demographical factor, namely education, did not significantly contribute towards explaining individual investor risk tolerance behaviour. Nonetheless, all the other endogenous factors and all the exogenous factors significantly contributed towards explaining individual investor risk tolerance behaviour. This led to the successful development of the multifaceted and sophisticated risk profiling model, which incorporated a multitude of pre-identified endogenous and exogenous factors to profile investor risk tolerance behaviour. Overall, the research study contributed to the enhancement of existing literature regarding the various aspects of the risk tolerance behaviour and investment decision-making of individual investors. It also provides individual investors, financial planners and investment companies with better insights and comprehension regarding the endogenous and exogenous factors that influence the risk tolerance behaviour of individual investors when making investment decisions. The risk profiling model will contribute significantly to the improvement of existing and conventional risk assessment forms by recommending a framework that makes provision for client-specific questions by considering pre-identified endogenous and exogenous factors that influence investor risk tolerance behaviour. Accordingly, the risk profiling model will facilitate the more practical, executable and accurate profiling of the risk tolerance behaviour of individual investors and successful investment decision-making in practice. Considering the limitations and implications of the research study, future research endeavours can engage several investment companies to take part in the research study to analyse the effect of endogenous and exogenous factors on individual investor risk tolerance behaviour from the databases and perspectives of several investment companies. Furthermore, a mixed-methods research approach can be followed, by also incorporating qualitative interviews to examine the rationales for the influence of endogenous and exogenous factors on individual investor risk tolerance behaviour. Given that the risk profiling model is multifaceted and sophisticated, the review and further investigation of the multitude of pre-identified endogenous and exogenous factors incorporated into the model to profile investor risk tolerance behaviour will assist to further refine and simplify the model. Larger sample sizes can also be utilised to review the robustness of the risk profiling model and accordingly, to profile the risk tolerance behaviour of individual investors even more accurately.Doctora