 Risk tolerance: Essential, behavioural and misunderstoodGreg B. Davies and Peter Brooks () Journal of Risk Management in Financial Institutions, 2014, vol. 7, issue 2, 110-113 Abstract: An understanding of an investor's risk tolerance is essential to determining investment suitability and yet there is no universally agreed definition of what risk tolerance is. The authors discuss the need for a holistic approach to measuring risk tolerance that provides a consistent framework for constructing efficient multi-asset allocation and ensuring a suitable aggregate level of risk and return, given the investor's personality and financial circumstances. Risk tolerance is only stable when considered as a personality trait, which can be measured effectively using holistic psychometric scales. Attempts to measure risk tolerance at lower levels of granularity are unstable, they accentuate, rather than mitigate short-term behavioural distortions and cannot be meaningfully aggregated to provide an overall level of risk that is appropriate given the investor's risk capacity. This implies that the recent move towards mental accounting, goal-based, assessments of risk tolerance is misguided and exposes institutions to risks associated with providing unsuitable advice. Keywords: holistic risk tolerance; investment suitability; portfolio construction; investing behaviour (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:aza:rmfi00:y:2014:v:7:i:2:p:110-113 Access Statistics for this article More articles in Journal of Risk Management in Financial Institutions from Henry Stewart Publications |
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