Investor Attitudes towards Risk and Uncertainty and Reactions to Market Turmoil

In order to assess how individual small investors have reacted to recent adverse events in world financial markets and whether these reactions are mediated by their risk attitudes, a survey was administered to N=120 members of a university community. The survey administered a standard risk tolerance instrument, augmented with questions on specific aspects of attitudes towards risk and uncertainty and with items asking about investing behavior and experience. Other items asked whether respondents had actually suffered investment losses during this time period, whether such events had an emotional impact on them, and whether they had changed their investment strategy as a result of these experiences. Initial analyses confirmed the view that investment risk tolerance is not a unidimensional construct. In particular, attitudes towards risk and towards uncertainty can be distinguished, and both components contribute to improving prediction of the riskiness of an individuals’ actual investment portfolio. Importantly, investor experience (both real and self-perceived) correlated positively with the self-report measure of portfolio risk. In order to investigate whether investment risk attitudes mediate reactions to market turmoil and to actual investment gains and losses, a path model was fit to the data. The results confirmed that investment risk tolerance predicts a measure of actual risk of the investor’s portfolio; portfolio risk in turn predicted whether or not the investor had suffered significant losses in portfolio value as a result of the recent market disruptions. Self-reported actual portfolio losses correlated positively with negative emotional reactions. Finally, both risk tolerance and negative emotional reactions to losses predicted self-reported changes in investment strategy. Investment risk tolerance (IRT) did not directly influence emotional reactions, nor was it proven to buffer the negative emotional effects of large portfolio losses, though a trend in that direction was observed. This may be due to a double effect of risk tolerance: on the one hand, investors’ emotional reactions to losses may be mitigated by higher levels of risk tolerance, but on the other hand higher levels of risk tolerance are associated with riskier portfolios, and thus to higher exposure to actual losses in a market downturn. 3 Risk Attitudes/MarketTurmoil