Risk taking , risk attitude , risk perception , presentation format , decision comprehension , experience-description gap
Abstract:
Financial professionals have a great deal of discretion concerning how to relay information about the risk of financial products to their clients. This paper examines how different risk presentation modes influence how well investors understand the risk-return profile of financial products and how much risk they are willing to accept. We analyze four different ways of communicating risk: (i) numerical descriptions, (ii) experience sampling, (iii) graphical displays, and (iv) a combination of these formats in a ‘risk simulation’. Participants receive information about a risky and a risk free fund and make an allocation between the two in an experimental investment portfolio. We find that risky allocations are elevated in both the risk simulation and experience sampling conditions. Greater risky allocations are associated with decreased risk perception, increased confidence in the risky fund, and a lower estimation of the probability of a loss. Despite these favorable perceptions the risky fund, participants in the risk simulation underestimate the probability of a high gain and are more accurate on comprehension questions regarding the expected return and the probability of a loss. We find no evidence of greater dissatisfaction with returns in these conditions and observe a willingness to take on similar levels of risk in subsequent allocations. Our paper has important implications for the current debate surrounding how financial advisors assess the suitability of investment products for their clients.
Additional information:
Available at SSRN: http://ssrn.com/abstract=1616186 or http://dx.doi.org/10.2139/ssrn.1616186
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