A quantitative investigation into the determinants of risk capacity

Mestrado Bolonha em Mathematical FinanceFor financial advisers, the Risk Profile is a crucial component of delivering the best possible experience to the client. This Risk Profile is composed of Risk Capacity, which relates to the socio-economic situation that the investor finds themselves in, and Risk Tolerance, which is associated with the psychological composition of the investor. Risk Tolerance is vague and of questionable use to the adviser in terms of determining the Risk Profile. Risk Capacity, conversely, can be measured objectively using data that is easy to obtain and process. Risk Capacity then, rather than Risk Tolerance, should be both the focus of academic research and the foundation of the Risk Profile. However, this is not true in reality. This project attempts to correct this misallocation of attention by quantita- tively assessing the determinants of Risk Capacity. It measures the effect that investment horizon, goals, net income, and net assets have on the ability of the investor to take risks using simulations via Monte Carlo methodology, mathematical derivation utilising prob- ability theory, and logical analysis. The conclusions of this project are that investors with a long investment horizon, small and flexible goals, small and stable expenses, and large and liquid net assets are able to take more risk. These findings have varied implications for advisers and supply the framework from which a model of Risk Capacity could be based on.