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Risk Preferences of Investors

In: Robo-Advisory

Author

Listed:
  • Monika Mueller

    (FCM Finanz Coaching)

  • Paul Resnik

    (FinaMetrica Risk Profiler)

  • Craig Saunders

    (Financial Suitability Forum)

Abstract

An investor’s risk preferences are captured in their “risk profile” characterized by the balanced state of different dimensions of risk. A person’s financial risk tolerance is the foundation of their risk profile. Risk profiling is a regulatory requirement for both humans and robo-advisors. But there is no agreement on exactly what should be considered in a risk profile, how measurements should be taken, or how data should be weighted in making recommendations. The core questions to be resolved are the following: What methodology will produce valid and reliable risk-tolerance assessments? How is that methodology to be effectively deployed in the advice process? Robo-advisors approach risk profiling at a disadvantage due to their limited data points compared to a human who can observe and question. Compared to a human-based system, a robo-advisor faces extra challenges in developing understanding, writing comprehensive algorithms, and applying professional judgment.

Suggested Citation

  • Monika Mueller & Paul Resnik & Craig Saunders, 2021. "Risk Preferences of Investors," Palgrave Studies in Financial Services Technology, in: Peter Scholz (ed.), Robo-Advisory, chapter 0, pages 35-51, Palgrave Macmillan.
    • Handle: RePEc:pal:psincp:978-3-030-40818-3_3
    DOI: 10.1007/978-3-030-40818-3_3
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    References listed on IDEAS

    as
    1. Moshe Levy & Haim Levy, 2013. "Prospect Theory: Much Ado About Nothing?," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 7, pages 129-144, World Scientific Publishing Co. Pte. Ltd..
    2. Cohn, Richard A, et al, 1975. "Individual Investor Risk Aversion and Investment Portfolio Composition," Journal of Finance, American Finance Association, vol. 30(2), pages 605-620, May.
    3. repec:cup:judgdm:v:4:y:2009:i:1:p:20-33 is not listed on IDEAS
    4. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    5. Grable, John & Lytton, Ruth H., 1999. "Financial risk tolerance revisited: the development of a risk assessment instrument," Financial Services Review, Elsevier, vol. 8(3), pages 163-181.
    6. Van de Venter, Gerhard & Michayluk, David & Davey, Geoff, 2012. "A longitudinal study of financial risk tolerance," Journal of Economic Psychology, Elsevier, vol. 33(4), pages 794-800.
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    Cited by:

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