An Empirical Analysis of the Risk-Return Preferences of Individual Investors

A common dilemma faced by investors and portfolio managers is the tradeoff preference between risk and return. The general consensus and convention in finance and economics is that, in the aggregate, investors do not seek risk for its own sake. If so, it is reasonable to assume that returns on individual common stocks vary according to their risk. However, it is not the purpose of this paper to examine the ex post risk and return experience of various financial assets. This and related work have been treated by Sharpe [22] and by others. While some of these are studies of individual common stocks, the majority involves the ex post risk-return relationships of portfolios managed by institutional or professional investors. Although the conclusions are not totally consistent concerning the shape of the risk-return function, there is agreement that a generally positive relationship exists between risk and expected return. To date, little empiricism has been directed specifically to the ex ante risk-return preferences of individual common-stock investors. This paper takes a step in this direction by analyzing the ex ante risk-return preferences and expectations of individual common-stock investors. The purpose is two-fold: (1) to provide positive (as opposed to normative) evidence on the nature of the relationship between acceptable risk levels and expected annual rates of return; and (2) to examine the nature of this relationship between risk and the components of total return, income from dividends and capital appreciation.