Risk Perception in Investment: A Historical Literature Review

CHAPTER II
REVIEW OF LITERATURE
In this section, the literature review including six parts. Initially, the
history of risk perception perspective was derived then investment risk
perception from investor perspective was focused then return perspective and
perceived risk was focused then research studies in investment risk perception
was focused then perceived control perspective was focused and finally,
Individual investor’s risk perception and their sensation in Stocks, Mutual Funds
and ULIPs has been reviewed.
2.1 HISTORY OF RISK PERCEPTION PERSPECTIVE
Year Review
1973 Payne of Duke university in Florida observed that the observed
correlation between return distribution moments and risk perceptions is
spurious and results from decision maker’s focus on loss or the possibility
of realizing a return below some target or aspiration level.
1973 Gooding a financial scholar has provided an extensive discussion of
perception from a behavioral perspective was on the subject of investor
perception. While only a few economists have addressed the notion of
perception in a substantial manner in works by Schwartz (1987), Schwartz
A Study on Perceived Risk in Investment with reference to Investor of Stocks, Mutual Funds & ULIPs 29
(1998), and Weber (2003, in press).
1974 Kaplan et al. and Taylor’s study of perceived risk has a long history in the
marketing literature. Researchers generally agree that perceived risk is a
combination of the perception of the likelihood that something will go
wrong and the perception of the seriousness of the consequences if it
does.
1975 McDonald and Stehle, Perceived risk is an ex ante measure which may be
based on past returns, fundamental analysis, present hunches, and all
other information that analysts believe to be germane.
1977 Cooley of New York university observed research, using utility based
models suggested that perceived risk might be measured by return
distribution moments such as variance and skewness.
1982 Paul Slovic, a founder and President of Decision Research, studies human
judgment, decision making, and risk analysis argued that Public
perceptions are often influenced by risks that have a particularly
catastrophic downside, however small, or which have had a high profile:
“discussion of a low-probability hazard may increase its memorability
and imaginability and hence its perceived riskiness, regardless of what
the evidence indicates”.
1982 According to Paul slovic, Baruch Fischhoff and Sarah Lichtenstein,
Studies of risk perception examine the opinions people express when they
are asked, in various ways, to characterize and evaluate hazardous
activities and technologies. Improving methods for eliciting opinions
about risk and providing a basis for understanding and anticipating
public responses
1984 Covello et al, While there will be perceptions and responses to risk
common across a range of groups in society as suggested earlier, it
remains that conflicts often arise between experts and the broader
community about acceptable risks
1985 Slovic's later research in risk perception discovered various factors that
affect risk perception, such as the potential for large or catastrophic losses,
unpredictability of outcomes, knowledge or familiarity, and affective or
emotional reactions (Slovic, Fischhoff, & Lichtenstein, 1985).
1986 MacCrimmon and Wehrung from the field of management define
perceived risk into 3 main groupings: 1) the amount of the loss, 2) the
possibility of loss, and 3) the exposure to loss. Perceived risk is a person’s
opinion (viewpoint) of the likelihood of risk (the potential of exposure to
loss, danger or harm) associated with engaging in a specific activity.
1987 Covello and Johnson suggested that societies select particular risks for
attention and that risks are therefore “exaggerated or minimized
according to the social, cultural, and moral acceptability of the underlying
activities”.
1988 Kasperson et al., explained, Public reaction may indeed be influenced by
initial perceptions of risk but these perceptions will in turn be affected by
how a community has prepared for and is currently responding to such a
crisis.
1989 White and Truly, prior research examining risk perceptions in marketing
has found that risk perceptions are negatively correlated with willingness
to buy. After all, as perceived risk of purchasing decreases, consumers’
willingness to buy increases.
1990 Monroe observed that perceived benefits are a combination of different
attributes of products (tangible and intangible; intrinsic and extrinsic etc.),
available in relation to a particular buy and use situation. Perceived
sacrifices are a combination of a nominal price and all other costs of
product acquisition and its use.
1990 According to Renn, Perceived risk is a person’s opinion (viewpoint) of the
likelihood of risk (the potential of exposure to loss, danger or harm)
associated with engaging in a specific activity. He provided a key
summary of findings in which perceived risk is a function of the
following:
i. Intuitive heuristics, such as availability, anchoring, overconfidence,
and others;
ii. Perceived average losses over time;
iii. Situational characteristics of the risk or the consequences of the risk
event;
iv. Associations with the risk sources;
v. Credibility and trust in risk-handling institutions and agencies;
vi. Media coverage (social amplification of risk-related information);
vii. Judgment of others (reference groups); and
viii. Personal experiences with risk (familiarity). (p. 4)
1992 Kahneman,Tversky, march and Shapira expressed that Individuals are
subject to framing effects, which may tend to focus their attention on
perceived risk dimensions
1992 Sitkin and Pablo defined risk perception as risk assessment in uncertainty
and it is determined from the questions investors ask, their familiarity
with the organizational and management systems etc. all of which are
important factors. Risk perception and prospensity to risk have a strong
negative correlation.
1992 The propensity to build up risk can further affect actual behavior, where
risk refers to how far decision makers are prepared to extend their
exposure to risk (Sitkin and Pablo, 1992). Risk perception forms the basis
of risk communication which means that people facing uncertainty and
ambiguity in the available information, construct inferences and draw
conclusions for them.
1993 Woodruff, Customer perceived value is a multidimensional concept,
which presents a trade-off between benefits and sacrifices perceived by
customers in a supplier’s offering.
1994 Guerin & Guerin’s observed that A range of situational factors and
knowledge, beliefs and attitudes influence the perceived risk of
innovation.
1995 Sitkin and Weingart extend the Sitkin-Pablo model leading to the
definition that risk perception and propensity are the mediators in risk
behaviors of uncertainty decision-making. In this hypothesis, past
investment establishes the frame for the propensity to risk, risk transfer,
and risk awareness which impact decision-making behavior. Thus risk
orientation and risk perception are reduced to antecedent variables in
decision-making behavior under risk.
1995 The research endeavor by Sitkin and Weingart’s 2nd study investigated
the association between a framing problem, risk perception, and risk
taking behavior.
1995 Fischhoff suggests that, once they discover that they have a risk problem,
organisations, industries and governments need to refine their risk
communications strategies by moving rapidly
1996 Margolis notes that “risks that are statistically microscopic can prompt
very substantial visceral perceptions of risk, while much larger risks are
perceived as negligible”
1997 The experimental study only analyses risk perception and does not
require subjects to choose between alternatives, the following will focus
on risk measures leaving aside specific models combining risk and value
into a preference index (cf. Dyer/Jia 1997; Sarin/Weber 1993 for
summaries of relevant models).
1997 One of the reasons that perceived risk predicts choice better than outcome
volatility is that perceptions of riskiness incorporate affective reactions to
outcome uncertainty, which also drive choice E.U. Weber & Milliman,
1997).
1999 Economic beliefs and attitudes play a major role in modern life. Whereas
attitudes toward money have been fairly well investigated, research is
scant on the perception of economic risks. It is of particular interest to
investigate financial risk perception as contemporary economies expose
the individual to personal risks that were traditionally managed
collectively or institutionally (Lunt, 1999). This means that there is an
increasing tendency to shift financial risks onto the individual who
consequently has to manage more complex and uncertain issues
pertaining to money.
1999 Rindfleisch and Crockett who suggest that perceived risk should be
considered a multidimensional concept entailing multiple types of risks,
including financial, performing, physical, psychological, and social risk.
2000 Sjöberg that Nonetheless, the availability heuristic is generally regarded
as the most important for understanding risk perception, although it has
been argued that this still only explains a small amount of the variance
found between perceived risks.
2000 Finucane’s suggested that substantive report on risk perception reviews
research on the influence that rural settings have on perceived risk.
Greater independence created by the isolation of rural settings might lead
to greater risk tolerance, but sometimes feelings of vulnerability resulting
from that isolation can heighten concerns about risks. Finucane’s review
also found mixed opinions on the degree to which socio-demographic
characteristics influence particular risk perceptions.
2000 Petts & Leach observed trust is thought to be one of the most important
influences on how people perceive risk and respond to risk
communications
2000 The availability heuristic is generally regarded as the most important for
understanding risk perception, although it has been argued that this still
only explains a small amount of the variance found between perceived
risks (Sjöberg 2000). The availability heuristic relates to the ease with
which an instance is brought to mind.
2000 Forlani and Mullins investigated how the issues of risk, risk perceptions,
and propensities to endure risks affect their decision-making process for
potentially risky ventures.
2000 Mileti that peoples’ protective response is directly related to their
perceptions of risk immediately prior to taking action and that emergency
warnings play a pivotal role in these perceptions.
2001 Dalgleish & White observed that since people are more cautious when it
comes to novelty, the rate of adoption tends to increase as novelty
decreases.People who are more self-confident are less likely to wait and
see how others have gone before taking up the innovative practice.
2001 Victor ricciardi stated risk perceptions are influenced by social and
cultural factors such as trust, fairness and democratic values. It always
contains an emotional or affective dimension and the basic characteristics
of the narrative research reviews from the risk perception literature in
behaviour finance.
2001 Diacon and Ennew investigated the risk perceptions of various personal
financial products among a collection of behavioral risk characteristics
(i.e. many based on Slovic and his co-authors of the Decision Research
Group) and financial risk indicators.
2002 Wejnert states that an individual’s familiarity with a particular innovation
influences how an individual will perceive the risk of that innovation.
2002 Slovic and Weber have pointed out that while the management of
extreme events will surely look to risk assessment for guidance, the
development of policy is a political enterprise involving for example
choices that must recognize the distinctions between public perceptions of
risk in comparison to technical risk estimates. Equally important, these
judgments need to consider how people would make tradeoffs to reduce
risks and consequences and the public’s level of trust in the mechanisms
selected to manage and respond to risk.
2002 Perceptions of risk are affected by anchors, which lead investors to raise
their returns expectations when given a bias/anchor of a higher value
(Jordan and Kass, 2002).
2002 According to Macintosh, Perceived risk is the least studied concept of
sacrifices.
2004 Hallahan et al identified key factors influencing portfolio choice for
individual investor is of importance, particular in the role of risk
perception.
Koonce, McAnally, & Mercer analyze the risk perception of different
2005
financial items presented by product types. Their findings suggest that
product-specific labels affect risk perception and that the presentation of a
specific cash flow as a financial derivative increases the risk investor’s
associate with that cash flow.
Kathleen Byrne’s study examines the effects of risk perceptions and

2005
expectations of returns.
2006 Much has been learned by social scientists regarding peoples’ perception
of risk, how people are likely to respond to different types of hazards and
about effective risk communication (Taylor-Gooby & Zinn, 2006).
Ronay and Kim have pointed out that there is no difference in risk
2006
attitude between individuals of different gender, but between groups of
such, males indicate a stronger inclination to risk tolerance.
The relationship between emotion and risk perception may affect

2006
behaviors that managers and policy makers care about Gigerenzer (2006).
Veld and Veld-Merkoulova stated that risk perceptions for individual

2008
investors are explored by experimental design on their potential concepts
about risk exposures. Some authors indicate that investment decision is
determined by financial risk taking and risk tolerance
2.2 INVESTMENT RISK PERCEPTION AS OF INVESTOR PERSPECTIVE
In 1960, Bauer noted, consumer behavioralist introduced the notion of
perceived risk. When he provided this perspective: Consumer behavior involves
risk in the sense that any action of a consumer will produce consequences which
he cannot anticipate with anything approximating certainty, and some of which
are likely to be unpleasant. At the very least, any one purchase competes for the
consumer’s financial resources with a vast array of alternate uses of that money.
Unfortunate consumer decisions have cost men frustration and blisters, their self-
esteem and the esteem of others, their wives, their jobs, and even their lives. It is
inconceivable that the consumer can consider more than a few of the possible
consequences of his actions, and it is seldom that he can anticipate even these
few consequences with a high degree of certainty. When it comes to the purchase
of large ticket items the perception of risk can become traumatic. (p. 24)
Slovic (1972) studied investment decisions and discovered that people
conceptualize risk is numerous ways, and that variance of returns is not a
reliable predictor of risk taking. In particular, Slovic showed that in decision
making under uncertainty, people use rules such as minimizing possible below-
target return or maximizing possible gain. This finding was corroborated by
Gooding’s (1975) study of investor perceptions of the risk and returns of
common stocks, which revealed significant differences between professionals
and nonprofessional investors.
A wide range of other definitions of financial and investment risk
perceptions appear in publications for the financial academic or investment
professionals. Crowell (1973) supports the notion of beta, however, recommends
that investors have financial knowledge of fundamental analysis, technical
analysis, price-earnings ratios, and economics in order to be familiar with other
measurements of risk.
Investors in the process of assessing the risks and returns are influenced
by this anchor effect (Tversky and Kahneman, 1974). Kahneman and Tversky
claim that in the process of assessment, people use certain starting values as
reference points, and that these reference points may be volatile values to which
subjects add necessary adjustments. The KT experiment demonstrates that this
adjustment is usually not reliable and people confronted with different situations
produce different anchor values. Investors use market reports to assess a starting
point value (Kahneman and Tversky, 1974) and heuristics to adjust their
assessment according to their own synthesis of the reported information. So, the
importance of psychological factors in investment decision-making is significant.
Kahneman and Tverskey (1979) proposed the use of a psychological point
of view in the well-known Prospect theory to explore the psychological behavior
of investors, and the Value Function to replace the traditional expected utility
theory. “Value Function” holds that a different attitude to risk prevails amongst
investors when facing the prospect of either gain or loss.
Covello (1984) studied that while there will be perceptions and responses
to risk common across a range of groups in society as suggested earlier, it
remains that conflicts often arise between experts and the broader community
about acceptable risks.
McInish and Srivatava (1984) utilized extensive regression analysis in
order to examine whether the association was prevalent between an investor’s
perception of the risk/relationship characteristics (i.e. beta, standard, skewness,
expected returns) of an individual stock and demographic factors (i.e. sex, age,
income, education). The authors make the case that even though investor
expectations play a significant role in financial models; little empirical
examination has been conducted regarding investors. variable expectations
however, standard finance models assume investors. expectations are
efficient and homogeneous.
Black (1986) laid the foundation by emphasizing the role of noise on a
wide range of economic activities, including financial markets. If there are only
trades on information, ‘‘taking the other side’s information into account, is it still
worth trading?’’
Slovic (1987) comments, “risk means different things to different people”
as indeed the differences between lay and specialist risk perceptions are likely to
reflect their differing understandings, values, and measures.
Harper, Mister, & Strawser (1987) studied that investors’ risk perception
to vary with the balance sheet classification of financial instruments. Because it
has been shown that information in the footnotes receives considerably less
attention than information in the balance sheet or the profit and loss statement.
Sjöberg (1987) is much more explicit. Rather than suggesting that it is the
perception of risk that is influenced by the lack of trust in modernity associated
with this type of dread risk, he defines risk in terms of this type of neglect: “Risks
are typically produced as side effects to some industrial programs. Risks are
often produced when dangers are overlooked or underestimated”. This approach
is consistent with that of Ulrich Beck, which suggests a new use of the term risk
in the literature that appears to blur the issue of perception with attempts to
describe levels of risk.
Cvekovich (1989) observed that although little or no research has been
undertaken to compare specifically the risk perceptions of specialist and lay
investors, the comparison of expert and lay understandings about physical and
technical risk has identified some important differences also he stated observed
the conventional response to the finding that experts and lay investors have
different perceptions and understandings about risk to institute risk
communication programmes designed to re-educate consumers in order to bring
their erroneous perceptions. However this approach has been criticized as being
inadequate.
(Morgan & Henrion 1990:64) Disagreement among experts can cause
confusion in the public mind about the validity of risk assessments as well as
providing a further area of uncertainty in the risk analysis itself .
Lee et al. (1991), he uses an index of closed-end fund discounts to proxy
for individual sentiment, and finds that individual investor sentiment, as
reflected by closed-end fund discounts, is capable of forecasting small firm
returns, even after controlling for dividend yields and termspreads. He also finds
that closed-end fund discounts are not able to predict returns on larger
companies.
Douglas (1992) his research suggests that conflicts arise from differences
in the way the public and ‘experts’ perceive risk, which is of particular concern to
policy makers basing their decisions on scientific advice.
Tversky and Kahneman (1992) stated line of reasoning would be
consistent with theory that posits that it is not actually an aversion toward risk
that people harbor, but rather an aversion to loss.
Wharton 1992:10; Margolis 1996:100, Public perceptions are often
influenced by risks that have a particularly catastrophic downside, however
small, or which have had a high profile: “discussion of a low-probability hazard
may increase its memorability and imaginability and hence its perceived
riskiness, regardless of what the evidence indicates” (Slovic et al. 1982:465). This
tendency to over-estimate high profile or memorable events is an example of the
availability heuristic and is borne out elsewhere in the literature.
Pablo and Sitkin (1992) An important factor of risk propensity is based on
past experience. Past investment experience can be treated as an anchor value in
investment decision-making. When investors have more investment experience,
this is representative of their optimistic investment behavior meaning that their
risk tolerance is higher.
De Bondt (1993) found that individuals rely on their personal pat
experience as a foundation and it is from this that excessive self-confidence in
decision-making can originate. Such investors make inappropriate decisions with
insufficient information due to this personal trait (Shefrin and Statman (1994).
Adams (1995) observed that people have a level of risk with which they
feel comfortable and will adjust the riskiness of their behaviour in the presence of
safety measures. Adams calls this tendency the individual’s “risk thermostat”
and uses it to explain why people tend to drive faster when they have airbags
and child restraints fitted in their cars
Hopkins (1996) summarized that with respect to the balance sheet
classification of hybrid financial instruments, obtains the similar result that a
labeling effect exists in the individual perception of financial information.
Swaminathan (1996) examines the predictive power of individual investor
sentiment on excess expected returns of small firms.
Margolis (1996) argues, “In the usual story, what is accounting for the
stubborn conflicts is less what experts see that other people miss, but what
ordinary people feel about risk that experts neglect”.
Capon et al. (1996) found that return and risk comprise only part of the
decision process for both individual investor and expert investor, and that
attributes other than returns and the risk are actively considered in personal
investment decisions. . Of course the individual investors’ lack of knowledge and
understanding about financial matters often means that they turn to a group of
expert and qualified professionals for financial advice. The key issue here is
whether this expert financial investor (who may be working as independent
financial advisers or as employees or tied agents of an investment provider)
thinks about investment risk in the same way as their clients. One of the ways
differences between expert and lay opinions like these is explained is that the
two groups have “rival rationalities”, suggesting that the lay person looks at risk
more broadly than the expert whose expertise is narrow and therefore likely to
“miss something” of importance to the broader community.
Barents Group LLC (1997) studied that India’s household savings and
foreign investors are key sources of this capital and can and will be increasingly
attracted to more efficient, safe and transparent market. Retail investors in India
are mostly short-term traders, and day trading is not uncommon. To the extent
that buying publicly traded equities is perceived as a risky and speculative short-
term activity, many potential investors will simply avoid capital market
instruments altogether in deciding to allocate savings.
Weber and Hsee (1998) Respondents’ risk perception was measured by a
numerical response to the following question: "How risky is this option, on a
scale from 0 (no risk at all) to 100 (extremely risky)?" As was predicted, Chinese
risk ratings were significantly lower than those of the Americans. Individual
subject regressions, using Equation l that predicted the prices a person paid for a
set of risky investment options as a function of the options' expected value and
that person's judgments of the options' riskiness showed that there were no
significant cultural differences in risk-value tradeoff coefficient b . After factoring
out cultural differences in the perception of the riskiness of choice opdons, both
nationalities were equally perceived-risk averse and lowered the prices they
were willing to pay for risky options by the same amount for each unit of
perceived risk.
The study by MacGregor, slovic, Berry and Evensky (1999) focused on
how the financial decision making process is linked to various aspects of
investments specially perceptions of returns and risk associations.
Gigerenzer & Todd, (1999) stated familiarity bias is an inclination that
alters an individual’s perception of risk. The phrase familiarity has been
described as “to denote a degree of knowledge or experience a person has
respect to a task or object
Most of the recent research on risk perception has asked respondents to
evaluate potential sources of risk along several characteristics and these
responses are analyzed to derive a number of underlying risk dimensions (this
methodology is known as the psychometric paradigm). MacGregor and Slovic
(1999) used this method to study the relationship between financial judgments
and perceived characteristics of investments such as risk, return and return/risk
relationship. That study revealed that professional financial advisors
conceptualize the risk of various asset types in terms of price and volatility (i.e.,
as postulated by standard financial theory), but these experts are also affected by
contextual (domain-specific) factors characteristic for specific investment class
(e.g., whether the investment is mutual fund, blue chip stock, U.S. Savings Bond,
foreign bond). Moreover, this study showed that financial advisors include in
their risk assessments factors like the stress associated with monitoring the
performance of an investment (asset), predictability of an investment’s
performance, potential loss-of-capital, and perceived adequacy of regulation.
Thus, financial advisors appeared to perceive financial risk in multidimensional
terms that are similar to those used by lay people in evaluating other risks in life
such as health and safety risks (see Slovic, 1987, for research in these domains).
Sjöberg (2001). Perhaps not surprisingly, Sjöberg found that “the public
was much more skeptical about the completeness of expert knowledge than the
experts themselves were”. Recent empirical research bears out this observation,
indicating that the public is more concerned about what the experts don’t know
and have a much stronger belief in the existence of “unknown effects”.
P. M. Deleep Kumar and G. Raju (2001) showed that the capital market is
becoming more and more risky and complex in nature so that ordinary investors
are unable to keep track of its movement and direction. The study revealed that
the Indian market is probably more volatile than developed country markets,
which is probably why a much higher proportion of savings in developed
countries go into equities. More than half of individual shareowners in India
belonged to just five cities. The distribution of share ownership by States and
Union Territories show that just five States accounted for 74.7 per cent of the
country’s share ownership population and 71.7 per cent of the aggregate value of
the shareholdings of individuals in India. Among the five States Maharashtra
tops the list with Gujarat as a distant second followed by West Bengal, Delhi and
Tamil Nadu. In the midpoint of the study also argued that introduction of
derivatives is the first step to hedge the risk of unfavorable movement in the
market. This will also lower transaction cost and provides depth and liquidity to
the market.
Sortino (2001) wrote recent research in the behavioral finance area claims
that investors do not seek the highest return for a given level of risk, as portfolio
theory assumes.. Rather than maximize the expected return, they want to
maximize a .satisfying. strategy.
Jordan and Kass (2002) argued that perceptions of risk are affected by
anchors, which lead investors to raise their returns expectations when given a
bias/anchor of a higher value.
Gutteling and Kuttschreuter (2002) observed that specialist investors have
been accused of an “affiliation bias” which may lead to an underestimation of the
risks involved in the industries in which they work. Experts will tend to think
about the impact of risk on a representative user or consumer whereas
individuals naturally tend to personalize such impacts
Harrison (2003) financial products investors often purchase investment
products by drawing on experience or through the investment appraisal process.
Therefore, past investment experience and expertise of investors provides them
with risk awareness and so have become important commodity risk assessment
factors in future. Some personal traits such as risk preference, and personal
experience affect risk assessment and awareness.
Harrison (2003) stated that the financial products investors often purchase
investment products by drawing on experience or through investment appraisal
process.
Leyla Şenturk Ozer, Azize Ergeneli and Mehmet Baha Karan (2004)
studied that the risk factor is one of the main determinants of investment
decisions. Market participants that are rational investors ultimately should
receive greater returns from more risky investments.
Koonce, Lipe, & McAnally (2005) show that a portfolio of financial
instruments containing a swap is perceived to be riskier than a portfolio without
a swap which generates exactly the same cash flows if it is explicitly stated that
the first portfolio does contain a swap and that the latter does not.
Rajeswari, T. R. and Moorthy, V. E. R. (2005) said that expectations of the
investors influenced by their perception and human generally relate perception
to action. The study revealed that the most preferred vehicle is bank deposit with
mutual funds and equity on fourth and sixth respectively. The survey also
revealed that the investment decision is made by investors on their own, and
other sources influencing their selection decision are news papers, magazine,
brokers, television and friends or relatives.
Koonce, McAnally, & Mercer (2005) and Koonce, Lipe, & McAnally (2005,
2006) stated that there is some convincing evidence that a distinction of financial
instruments exclusively by their type will result in a biased risk perception by
investors
Kathleen Byrne (2005) shows that risk and investment experience tend to
indicate a positive correlation and past experience of successful investment
increases investor tolerance of risk. Inversely, unsuccessful past experience leads
to reduced tolerance to risk. Therefore past investment behavior affects future
investment behavior.
Kathleen Byrne (2005) concludes that for expert investors traditional
theory holds true, but this is not so for novice investors. This study examines the
effects of risk perceptions and expectations of returns as applies to investors.
Corter and Chen (2006) Investors with more experience have relatively
high risk tolerance and they construct portfolios of higher risk. The success or
failure of past investor experience influences the tendencies of investors towards
risk and risk perception, and further affects decision-making behavior.
Chris Veld and Yulia V. Veld-Merkoulova (2006) found that investors
consider the original investment returns to be the most important benchmark,
followed by the risk-free rate of return and the market return. Study found that
investors with longer time horizon would generally be better off investing in
stocks compared to investors with shorter time horizon. They knew through the
question on risk perceptions that investors who are more risk tolerant would
benefit from relatively larger investment in stocks. Their study showed the
investors optimize their utility by choosing the alternative with the lowest
perceived risk.
Financial reporting principles have the potential to result in a biased risk
perception of investors if they do not assure that economically like situations are
reported alike (Gramlich, Mayew, & McAnally (2006); Koonce, Lipe, & McAnally
(2005); Hodder, Koonce, & McAnally (2001); Kennedy, Mitchell, & Sefcik (1998);
Hopkins (1996)).
Jannis Bischof & and Michael Ebert (2007) a presentation of financial
instruments by measurement categories causes significant biases in the risk
perception of non-professional investors. Those biases could be reduced either by
a reduction of management’s discretion in the choice of measurement categories
or by the introduction of a uniform presentation format that is neither based on
measurement categories nor on products but, for instance, on a company’s
investment purposes. Such an approach would be a further step towards a true
management approach in the disclosure of financial instruments.
Ravichandran (2007) argued the younger generation investors are willing
to invest in capital market instruments and that too very highly in Derivatives
segment. He also argued majority the investors want to invest in short-term
funds instead of long-term funds that prefer wealth maximization instruments
followed by steady growth instruments. Empirical study also shows that market
risk and credit risk are the two major risks perceived by the investors, and for
minimizing that risk they take the help of news paper and financial experts. The
investors should be aware of the various hedging and speculation strategies,
which can be used for reducing their risk. Though the stock market is subjected
to high risk, by using derivatives the loss can be minimized to an extent.
Frijns et al., (2008), and Veld and Veld-Merkoulova (2008) expressed in
terms of different risk perception or risk tolerance level, individual investor may
show different reaction base upon their psychology factor and economic
situation, which would lead to heterogeneous portfolio choice for individual
investors. For this reason, it is crucial to recognize and attitudinal how individual
investors with different risk perceptions and risk tolerance make their invest
products choice on investment plan, in particular socio-economic status
differentials may make their choice vary and difference.
Nidhi Walia and Ravi Kiran (2009) studied that to satisfy the needs of
investors mutual funds are designing more lucrative and innovative tools
considering the appetite for risk taking of individual investors. A successful
investor is one who strives to achieve not less than rate of return consistent with
risk assumed. They also argued as per observation by survey responses of the
individual investors fact is clear that overall among other investment avenues
capital market instruments are at the priority of investors but level of preference
varies with different category/ level of income, and an association exists between
income status of investors and their preference for capital market instrument
with return as objective.
Gaurav Kabra, Prashant Mishra and Manoj Dash (2010) studied key
factors influencing investment behaviour and ways these factors impacts
investment risk tolerance and decision making process among men and women
and those different age groups. They said that not all investments will be
profitable, as investor will not always make the correct investment decisions over
the period of years. Through evidence they proved that security as the most
important criterion; there is no significant difference of security, opinion,
hedging in all age group. But there is significant difference of awareness, benefits
and duration in all age group. From the empirical results they concluded the
modern investor is a mature and adequately groomed person.
Shyan-Rong Chou, Gow-Liang Huang and Hui-Lin Hsu (2010) notified
that less experienced investors have lower risk propensity and higher risk
perception. The opposite is true for more experienced investors. However
investors with less experience have extremely high risk perception.
2.3 RETURN PERSPECTIVE AND PERCEIVED RISK
Tarpey and Peter (1975) were not solely concerned with the consumers
Judgments as related to perceived risk (in which consumers minimize risk). They
investigated two Additional aspects: 1) perceived risk, in which the consumer
makes purchase decisions which maximizes perceived gain and 2) net perceived
return in which the decision maker’s consists both risk and return.
The emerging topic of attention and examination concerning the premise
of an inverse (negative) relationship between perceived risk and expected return
(i.e. perceived return, perceived gain) in a sample of inquiries including:
psychology in the area of hazardous activities in studies by Alhakami and Slovic
(1994) and Finucane, Alhakami, Slovic, and Johnson (2000), behavioral finance in
works by Ganzach (2000)
Sitkin and Weingart’s (1995) conclusion that the mediator of risk
perception and risk propensity causes a reduction of antecedent variables and
risky decision-making behavior. Thus experience and returns expectations have
a strong positive correlation, and the more extensive the investment experience,
the more optimism, self-confidence and returns expectations are raised. As such,
past experience is used as an anchor to set a start value and basis from which
future expectations and judgments will be made.
Informational constraints or bounded rationality may prevent ordinary
investors from considering correlations or covariance’s when making portfolio
allocations. However, at the very least, they should think about the expected
return and likely variance of assets return, or about other, more appropriate,
measures of risk (Sarin & M. Weber, 1993; E.U. Weber, 1999). This raises the
question of how investors might arrive at their expectation about the return and
riskiness of assets, given the types of information typically provided by
investment brokers, the Internet, newspapers, or other news services. One
possibility is that people use the past performance of investment options to
predict future performance, i.e., that they use historical returns to estimate future
returns and their likely volatility or risk. If so, the format in which historical
returns are presented might influence estimates of future performance.
Accounting measures of risk (i.e. financial ratios) are a component of the
market price based risk measure (i.e. beta or variance of returns). In some cases,
the accounting risk measures have even accounted for a greater amount of an
investor’s perception of risk than the traditional market risk measures (Lipe,
1998).
Lane and Quack (1999) provide the following perspective of risk: A
dictionary definition of risk is that of a state in which the number of possible
future events exceeds the number of actually occurring events, and some
measure of probability can be attached to them. Risk is thus seen to differ from
uncertainty where the probabilities are unknown. Such a definition is beholden
to mathematically inspired decision theory, and the rational actor, model, and
does not sufficiently consider the complexity of risk in business. (p. 989). Weber's
(1999) cushion hypothesis for behaviors other than risk taking-in particular, for
perceptions of the riskiness of risky options.
Grable and Lytton (1999) lament the lack of an instrument by which
financial advisors can assess the risk preferences of investors and note the
reliance of these advisors on demographic characteristics to assess risk attitudes.
In this respect, we think that the design of our Investment mean-variance based
measure could be used as a reasonable test of risk aversion, which can be used by
financial advisors to give people optimal advice.
In contrast to the findings of Thaler & Bernartzi (1999), there is very little
evidence that the time horizon of past performance charts has any influence on
the choice between an equity fund and a low risk/low return fund, or on risk
perceptions. The study finds that there is little or no evidence that respondents’
perceptions of risk and return are influenced by ‘cherry-picking’ the time horizon
of the charts to focus on periods of rising fund values as suggested by Clark-
Murphy & Soutar (2004). Although this may be an issue when investors have to
choose between different fund managers, or decide on fund composition, it does
not appear to arise when investors are asked to make a comparatively simple
choice between equity and a fixed interest fund.
The objective of the study by the MacGregor, Slovic, Berry and Evensky
(1999) was to obtain a better comprehension regarding how the financial
decision-making process is linked to various aspects of investments/asset
classes, specifically expert.s perceptions of returns, risk, and risk/return
associations
Olsen and Troughton (2000) found that a large sample of financial
professionals identified risk as the chance of incurring a large loss (i.e. downside
risk). Unser (2000) defined risk in terms of downside risk in which he utilized the
concept of Lower Partial Moments (LPMs).
Concerning the use of investor sentiment as a stock return predictor, both
Fisher and Statman (2000) and Brown and Cliff (2004) predominantly find that
sentiment follows stock returns more than it leads them.
Finucane (2002) pointed out; critical dimensions included dread risk (a
below-target return, the potential for a large loss, the investor’s feeling of control)
and unknown risk (the level of ambiguity or knowledge about an investment).
(p. 238).
The academic literature provides a wide range of financial, accounting,
and investment risk measurements over the years from the areas of standard
finance, behavioral finance, and behavioral accounting (Ricciardi 2004). Even
though standard deviation and variance have had a wide acceptance as a
financial risk measure for many years, scholars have varied in the application of
this statistical technique. For instance, several authors have defined the standard
deviation of expected returns as their risk measurement, as in works by Tobin
(1958), Hirshleifer (1961), and Cohen and Elton (1967).
Despite a wealth of literature and trained professional opinion supporting
the existence of a positive correlation between risk and return, some novice
traders and unskilled investors perceive expected return to be in negative
correlation to risk (Muradoglu, 2005) (Byrne, 2005). Normal investors are
affected by cognitive bias and emotions in decision-making behaviors, rational
investors are not (Statman, 2005).
(Stephen Diacon, 2005) The results of his study show that presenting past
information in terms of fund values (based on an index) or percent returns or
yields significantly affects the fund preference and risk perceptions of individual
retail investors.
2.4 RESEARCH STUDIES ON PERCEIVED RISK IN INVESTMENT
Baker and Haslem (1976) compared the decision making process of
common stock investors regarding their risk and return behavior for two main
groups of investors (independent investors that do not seek investment advice
vs. investors who seek the assistance of other individuals). A mailed survey to a
geographic area was filled out by 851 clients of a brokerage firm (542 who seek
the advice of others and 309 who make independent decisions) regarding their
attitudes towards different levels of risk (none, low, medium, high) as well as
their viewpoints on dividend income and capital appreciation. The findings
revealed: 1) Investors who typically make investment decisions by seeking the
assistance of others are prepared to agree to a lower risk of investment loss than
individuals who make independent judgments; 2) Clients who seek investment
advice or the opinions of others are more concerned in dividend income and are
more ready to accept less risk per level of dividend income than are self-reliant
investors; and 3) Independent investors are more concerned with capital
appreciation and are willing to accept greater risk per capital appreciation level
than those investors who are dependent on the advice of others.
The study by Oster (1976) employed a measure of investment risk known
as the Index of Riskiness. The author computed an average perception of risk for
each of the 21 stocks and this average perception of risk was identified as a new
risk measure referred to as the Index of Riskiness for laboratory experiments of a
total of 28 groups and 184 subjects. The two groups of subjects researched in this
sample had different perceptions of the majority of the 21 stocks provided. The
two groups of investors did not reveal a homogeneous view of perceived risk
towards the sample of stocks (two-thirds of their perceptions were different).
The study by Farrelly and Reichenstein (1984) expanded the work of
McDonald and Stehle in 1975; it focused on perceived risk on an individual basis
rather than a market wide perspective and the study utilized 6 financial risk
characteristics from Value Line. The authors collected the responses of the study
from a mailed survey to 209 financial analysts that asked their perceptions of risk
for a collection of 25 stocks. The study measured perceived risk by having
respondent’s rate risk perception on a scale of 1 (low) to 9 (high), and the names
of the stocks were disclosed however, no financial information was provided.
The authors selected companies for the survey that the respondents would be
familiar with from a cross section of industries. The best proxies for the experts
risk perception were measures that were broader than market beta: safety with
an r-square of 19% (subjective factor) and price stability with an r-square of 22%
(objective measure) were most closely correlated with their risk perception.
Safety was a measure of total risk that price stability accounted for 80% weight,
with the remaining 20% being a subjective factor (i.e. recent changes in a
company’s business or the quality). The best combination of objective measures:
beta and price stability explained 68% of the variation in perceived risk. The best
findings of subjective risk: safety and dispersion of analysts forecast explained
91% of the variation in perceived risk.
Once people have determined an assessment of a particular risk, their
opinions can be difficult to change (Covello et al. 1984:226; MacCrimmon and
Wehrung 1986: 41). This seems to be particularly the case if they feel they know
something about the subject – research has found that people are more likely to
be swayed by expert opinion in areas about which they know nothing than on
topics they believe they understand (Siegrist and Cvetovich 2000). People are
also selective in the evidence they will accept and more likely to see less risk in
cases where they see benefits from the activity (Ross and Anderson 1982:149;
Siegrist and Cvetovich 2000: 714). Supporters of the import of a new product are
therefore more likely to accept the associated risk than its opponents who will
regard it as riskier.
The prevalent technical jargon from the risk perception literature
emphasizes the terminology risk, hazard, danger, damage, catastrophic or injury
as the basis for a definition of the overall concept of perceived risk. Risk perception
seems to encompass both a component of hazard and risk; the concept appears
to entail an overall awareness, experience or understanding of the hazards or
dangers, the chances, or possible outcomes of a specific event or activity.
MacCrimmon and Wehrung (1986) from the field of management define
perceived risk into 3 main groupings:
i. The amount of the loss,
ii. The possibility of loss, and
iii. The exposure to loss.
Farrelly, Levine, and Reichenstein (1987), focus on the premise of a
collection of 15 financial ratios might serve to explain risk perceptions for 3
different risk classes of stocks (low, medium, and high risk) in which the
respondents rated each with the standard judgment perceived risk variable.
Cassidy and Lamb (1994) investigated the association between the
reported/perceived risk of insurance agents and the actual risk of a pool of
insurance companies (i.e. similar to building a portfolio stocks by an investment
manager). Two hypotheses that developed were:
i. Null Hypothesis: The actual risk encountered by insurance agents is
consistent with their perceived risk and
ii. Alternative Hypothesis: the actual risk encountered by insurance agents is
not consistent with their perceived risk.
Sitkin and Weigart’s (1995) business risk propensity model is used as a
framework model through which to record the responses of investors facing
uncertainty in investment research. The investors’ past experience is a variable
used to define an anchor effect, and their information source International
Research Journal of Finance and Economics - Issue 44 (2010) 21 provides a
framework for the farming. The investors face situations involving varying
degrees of uncertainty and their statements on their decision-making process are
recorded. The questionnaire focuses on investors responses in the optimism or
pessimism economic reports they receive. This provides the framework from
which the effect on the variables can be measured. Risk perception and risk
propensity are mediator variables. Investors, with their own unique experience,
face various different risk scenarios and their propensity to risk, and risk
awareness results in varying decision making behavior. Decision-making
behavior is ultimately reflected in their returns expectations for the financial
products accumulated, and their portfolio configuration. This research
framework is illustrated in Figure 1. The purpose of this study is to test for the
existence of relationships and the strength of any such relationships through the
application of the model. Therefore, this paper focuses on the relationship
between pairs of tests, rather than the fit of the whole model.
Figure 2.1
Model of determinants of the investment decisions
Risk Propensity Investment over the

Past Experience
Investment Risk Perception Return Expectation

Message/Informatio
n
Olsen (1997) employed in two stages a mailed questionnaire with a
research sample of 630 expert investors and 740 sophisticated novice investors.
Questionnaire #1 provided investors with an open-ended definition of investing
to obtain specific factors of risk perception, and Questionnaire #2 investigated
the specific representation each of these factors influenced investors. Risk
perception among 10 asset classes with a 7-point scalefor this 2nd survey. With
the completion of Questionnaire #2, the results of this study demonstrated both
groups of professional and individual investors appear to have a similar
perspective of risk. The author utilized two main statistical methods, which were
correlations and regression analysis. The four main risk characteristics that these
investors assign to their perceptions of risk were: the concern for a large loss, the
feeling of control, the potential for a below-target return, and a perceived degree
of knowledge.
Weber and Milliman (1997) utilized a stock simulation program in which
24 MBA finance students are provided with an initial investment of $100,000 and
asked to select between six investment choices. This research study focused on
three specific research questions:
1. Are stock selections different as a consequence related to a successful
investment vs. failed investment?
2. Is the perceived risk for stocks altered as the result of investment success
vs. investment failure?
3. Is transformation in investment decisions related to changes in perceived
risk, so that preference for perceived risk is constant for a given investor,
even though both choice and perception are being transformed?
In a study by Lipe (1998) that examined in two experiments whether
individual investors utilize accounting information (i.e. cash flow, earnings) vs.
market variables (i.e. variance and covariance of return) when measuring risk
and making investment decisions. The investment task involved the judgment of
the risk and return relationship for 6 stocks among 39 subjects for experiment #1
and 3 stocks for a group of 55 subjects from experiment #2. Subjects were asked
to ask assess each stock in terms of risk and return judgments by rating each
stock by the overall riskiness or rank order each stock within a group by
perceived risk.
Raghubir and Das (1999) suggest that theoretical and empirical
investigations of financial investment decisions ought to examine perception of
existing information, retrieval of information from memory, and integration of
multiple sources of information.
In this behavioral economics study on risk perception, Unser (2000)
utilized eight hypothetical discrete stock price distributions in order to measure
the influence of different target outcomes and structures (i.e. charts or
histograms) among 199 business students. This paper investigated an
individual’s risk perception in a stock market framework. The purpose was to
experimentally research private investors’ perceived risk in investment decision-
making in which the authors utilized 3 main sets of hypotheses.
Siebenmorgen and Weber (2000) examined the influence of different
investment time horizons (in the short term vs. the long run) on investors risk
behavior regarding their risk perception and asset allocation decisions. The
authors investigate framing effects concerning the arrangement of historical data
with 1-year vs. 5-year performance returns among 103 MBA students. The study
revealed that biases in risk assessments instead of biases in predicted volatilities
influence the tested investment behavior. Results demonstrated significant
underestimations of long-term risks in all 5 informational conditions that
resulted in a higher allocation of risky assets in a long-term portfolio. Two
exploratory reasons were provided 1) a belief in mean-reverting asset prices
seems to influence the more risk taking in the long-term by subjects and 2)
limited cognitive abilities attributed to framing effects.
The risk perception working papers in behavioral accounting by Koonce,
McAnally and Mercer (2001) and Koonce, McAnally and Mercer (2003) have
employed a collection of behavioral risk indicators which also comprise a
knowledge characteristic by Slovic and his peers from the risky activities studies
in psychology. The behavioral finance literature review showed the affiliation
between the notion of knowledge/expertise and perceived risk within the
academic research has been a leading area of study since the mid-1980s in a
number of studies.
Koonce, McAnally and Mercer (2001) investigated the financial data on
risk in an accounting setting in which the authors implemented two laboratory
studies with 40 graduate business students for each experiment. In both studies,
the subjects assessed the riskiness of a series of 19 nonderivative and derivative
financial items; subjects were told to assume they had substantial ownership in
the stock of the company, each item was material to the firm, and to assess the
overall riskiness of each of the firm.
Muradoglu (2001) examined the behavior of individual investors based on
the notion of the overreaction hypothesis by performing a controlled experiment.
The author based this study on a collection of experiments by De Bondt in 1993;
this study extends past research by utilizing real time stock quotes and the use of
expert investors (the previous work only sampled student subjects). The results
of the study regarding the factors of expected return and perceived risk were
attributed to:
1. The existence of background information;
2. The movements in the financial markets; and
3. The level of expertise of the individual respondent.
Shefrin (2001) conducted several studies over a five year period with the
same group of eight stocks on a questionnaire that examined an alternative
premise of the risk and return relationship among student or expert investment
groups. The author makes the premise that behavioral finance is based on the
belief of a negative relationship between expected return and perceived risk (or
expected vs. beta). A discussion is made that suggests that investors are
dependent on the representativeness heuristic as the main clarification why
individuals relate higher perceived returns from safe stocks (lower risk perceived
stocks). Shefrin describes safer stocks as good stocks/good companies in which
persons view higher quality stocks based on such traits as the quality of the stock
(i.e. financial soundness) and the perceived goodness of the firm (i.e.
management reputation).
Diacon and Ennew (2001) investigated the risk perceptions of consumers
of various personal financial products among a collection of behavioral risk
characteristics (i.e. many based on Slovic and his co-authors of the Decision
Research Group) and financial risk indicators. The authors utilized a
questionnaire to six groups at organizational meetings for a total of 123
respondents in order to measure their perceived risk for various financial items.
For each of the 20 financial products, the respondent was asked, do you
own/have owned this product? In order to assess this potential investment
ownership judgment. The 25 risk characteristics were mainly behavioral in
nature (i.e. issues of losses, knowledge, and time) with a few financial risk
indicators. Factor analysis was employed to classify the 25 risk attributes into
five main risk dimensions including:
i. Mistrust of the investment product or source (i.e. a salesperson),
ii. The dislike for adverse outcomes,
iii. A distaste to the volatility of a financial product,
iv. Inadequate knowledge of an financial item,
v. The failure of regulation accounted for the variance of perceived risk.
The authors also explored the notion of an inverse relationship between
perceived risk and return (gain).
Diacon (2002) utilized the collection of 25 risk indicators across the 20
investment products from the previous work by Diacon and Ennew (2001). This
endeavor investigated the perceptions of investment risk by expert financial
professionals and personal consumers that incorporated a variety of financial
services such as retirement plans, savings instruments, banking products, and
investment products available to individual savers.
Dulebohn (2002) examined specific risk characteristics that workers
employ when making investment judgments for their employer-sponsored
retirement plans. A field survey of college and university employees (795
respondents) were given a questionnaire with a hypothetical situation that
requested them to decide on investment of eight allocation alternatives for a
fixed sum of $10,000 offered by defined contribution pension plans. The authors
employed a collection of 8 main hypotheses and utilized statistical methods such
as intercorrelations and regression to test them. The author investigated the
importance of specific behavioral and demographic factors regarding an
employees’ risk taking behavior within three risk constructs: 1) The ability for a
person to recover or cover a potential loss (income level, age, and investments in
other retirement plans); 2) the persons perceived personal control (internal locus
of control, knowledge, self efficacy); and 3) behavioral tendencies (gender,
overall risk propensity). The author used two measures for evaluating
investment risk: 1) an investment risk level in which respondents had to rate
each of the eight options with a risk scale of 1 to 8; and 2) a real loss tolerance
that was designed to assess the indicator for each person.
The Koonce, McAnally and Mercer (2003) working paper a revised
adaptation of the earlier work by the same authors in 2001. The authors develop
a new model of risk perception that incorporates both behavioral risk
characteristics and the standard decision theory (i.e. statistical probabilities and
expected value) pertaining to losses and gains. A central premise is that the
perception of financial statement users might be better understood and explained
by incorporating behavioral risk characteristics such as worry and control.
Another purpose of this study is to examine how users of financial statements
perceive risk for 19 financial items for various levels of risk within two
experimental studies.
2.4.1 Risk Perception Studies in Behavioral Studies
Table 2.1
The Details of Risk Perception studies in behavioral studies
Author(s) and No. of Actual Research Investment

Studies
Year(s) Subjects Sample Task
Mear and Firth (1988) ---- 38 Portfolio Managers 30 Stocks

Individual
Experient 1 39 6 Stocks
Investors
Lipe (1998)
Individual
Experient 2 55 3 Stocks
Investors
Graduate Business A collection
Study 1 40
Students of 19
Koonce, McAnally,
derivative
and Mercer (2001) Graduate Business
Study 2 40 and non
Students
derivative
Graduate
Group 1 29 Accounting
Students
Viger, Ben-Amar, 1 case
Graduate
Curtola, scenario for a
andAnandarajan fictitious
Students
(2002) company
Graduate
Students
Graduate Business A
Study 1 40
Students compilation
Koonce, McAnally,
of 19
and Mercer (2003) Graduate Business
Study 2 100 financial
Students
items
2.5 PERCEIVED CONTROL PERSPECTIVE
Personal control is the perception that one has the ability, resources, or
opportunities to get positive outcomes or avoid negative effects through one’s
own actions. The concept of control has been one of the most pervasive and
enduring ideas in psychological research and theory. Numerous theories posit a
important role in human behavior for control constructs such as self-efficacy
(Bandura, 1977), personal causation (deCharms, 1968), effectance motivation
(White, 1959), perceived control (Thompson, 1981), and helplessness (Seligman,
1975).
Personal control is an important predictor of health behaviors for several
reasons. First, individuals may need to feel efficacious in order to decide to make
behavior changes. If people do not feel they have the skills to change a particular
behavior, they are unlikely to exert the effort. Second, research on human
perception has found that feelings of helplessness generally decrease attempts to
change one's situation even when effective action is available (Seligman, 1975).
Pearlin and Schooler (1978) developed a general perceived control
(mastery) scale consisting of seven items rated on a 7-point Likert scale from
“strongly agree” to “strongly disagree.” Sample items include, “I often feel
helpless in dealing with the problems of life,” and “I have control over the things
that happen to me.” As an example of research using this scale, new mothers
with higher levels of mastery were more likely to engage in responsible maternal
behavior two years later and less likely to have further pregnancies in that period
(DeSocio, Kitzman, & Cole, 2003).
Levenson’s (1981) scale consists of 24 items measured on a 6-point
response scale ranging from –3 (strongly disagree) to +3 (strongly agree). The
scale includes separate measures of internality (general perceived control; 8
items), control by others (8 items), and the effects of chance (8 items). Sample
items include: “When I make plans, I am almost certain to make them work”
(internality); “I feel like what happens in my life is mostly determined by
powerful people” (control by others); and “To a great extent my life is controlled
by accidental happenings” (effects of chance). General perceived control, as
assessed with Levenson’s (1981) scale, has been found to predict amplification-
seeking among hearing impaired individuals (Cox, Alexander, & Gray, 2005).
Two-Process Model of Perceived Control. The model, as presented by
Rothbaum, Weisz, and Snyder (1982), makes a distinction between primary
control, which involves taking action to get desired outcomes, and secondary
control, which refers to changing oneself to adjust to the environment. Secondary
control also enhances an overall sense of personal control. The important
contribution of this approach to control is that it proposes that both direct action
on the environment and adjusting to the environment are sources of personal
control.
Researchers have generally operationalized perceived control as self-
efficacy, and it is possible that if research used measures of perceived control the
predictive power of the model would be further increased (Godin & Kok, 1996;
Terry & O’Leary, 1995).
2.6 INDIVIDUAL INVESTOR PERCEIVED RISK AND THEIR SENSATION
IN STOCKS, MUTUAL FUNDS AND ULIP’S
Most authors show behavior finance perspective on individual investor,
such as Deaux and Emswiller (1974), Lenney (1977), Maital et al. (1986). Those
authors are to exclaim that individual investor would demonstrate different risk
attitude when facing investment alternatives. Later instruction in our research,
we called risk perception and risk tolerance of individual investor. Comparing
with previously research, current study is to focus on external factors and
psychological factors how to affect investor’s investment decision and portfolio
choice. For instance, Annaert et al. (2005), Wang et al. (2006) indicate the impact
of information asymmetric problem on investor behave, this is another subject in
behavioral finance field. Most of these researches are pay close attention to
behavioral finance, especially in financial products choices (investment) and
behave of individual investor invest related.
One of the underlying principles of risk perception is the idea of the
availability heuristic based on the work of Tversky and Kahneman (1974). This
heuristic is utilized in order to judge the likelihood or frequency of event or
occurrence. In various experiments in psychology, findings reveal individuals
tend to be biased by information that is easier to recall, influenced by
information that is vivid, well-publicized, or recent. The significance of the
availability heuristic for providing explanation for perceived risk is apparent, for
the reason that probability assessments are a fundamental aspect of risk decision-
making.
In a geographic study by Baker, Hargrove, and Haslem (1977) examined
individual investors risk return preference towards common stocks with a two
step approach: 1) to determine the association between different parameters of
risk and expected return rates and 2) to find out how this relationship of risk and
return was linked to the specific aspects of expected return namely dividends
and price appreciation.
Seminal work by Tversky and Kahneman (1981) has shown that
individuals exhibit a number of heuristics or decision-making ‘shortcuts’ and
biases in making decisions (Slovic, 2000). More recently it has been demonstrated
that these effects extend to the area of saving and individual finance decisions
(e.g. Benartzi and Thaler, 2001, 2002). Goodman (2004) suggests that consumers
don’t have the time, inclination or aptitude for finance, while at the same time
they worry extensively about their financial welfare and its management.
Individual perceptions of risk are clearly relevant in making investment fund
choices (Diacon and Ennew, 2001; Warneryd, 2001; Jordan & Kaas, 2002). A
comprehensive review of the lessons from behavioural finance research can be
found in Mitchell & Utkus (2004).
MacCrimmon and Wehrung (1986) make the argument that each time the
aspects of a risky decision are not clearly known or measurable, an individual.s
perception must be subjective since the factors involved are not well defined.
Still, when risk factors are well known, an individual’s perception is still
subjective because of the personal quality of determining the likelihood of losses
and exposure to loss. In some cases, subjective risk measurements have even
outperformed objective risk variables (Farrelly and Reichenstein 1984).
Lee et al. (1991), he uses an index of closed-end fund discounts to proxy
for individual sentiment, and finds that individual investor sentiment, as
reflected by closed-end fund discounts, is capable of forecasting small firm
returns, even after controlling for dividend yields and term spreads.
(Tversky & Kahneman, 1992, Thaler, Tversky, Kahneman, & Schwartz,
1997) suggests that individuals elect more risky options when a long-term
horizon is imposed externally. Also, myopic loss averse investors accept risks
more willingly when they evaluate their investments less often. Investors,
therefore, seeking the most frequent feedback and more information take the
least risks and achieve the lowest returns. Investors also tend to accept more
risks when all payoffs increase enough to eliminate losses. In addition, people
overweight small probabilities, so if a decision is framed in such a way as to
indicate a small probability of incurring losses, then these small probabilities will
loom larger, and will also be additionally magnified by loss aversion (Tversky &
Kahneman, 1992).
In order to examine the risk perception of individual investors more
closely and to see which of the different risk measures deducted on theoretical
grounds pass the empirical test a study was designed to identify the
characteristics of a distribution that influence risk perception. It should be
stressed that this examination concentrates entirely on risk perception and does
not address people’s risk preferences or risky choice. The important distinction
between risk perception and risk attitude which both moderate risk behavior has
not been drawn in the relevant literature until a few years ago (Sitkin/Pablo
1992; Sitkin/Weingart 1995; Weber/Milliman 1997).
Studies in risk perception have found that individuals reveal unjustifiable
confidence in their decisions in works by Plous (1993) and Bazerman (1998),
issues of knowledge in studies by Fischhoff, Slovic, Lichtenstein, Read, and
Combs (1978) and Rao and Monroe (1988) and unwarranted beliefs in their
ability to achieve (perform) under risky conditions in studies by Slovic, Fischhoff,
and Lichtenstein (1980) and March and Shapira (1987).
In fact, prospect theory does not deal with the effects of past investor
experience on future investment behavior. Sitkin and Pablo (1992) developed a
model of determinants of risk behavior. In this model, personal risk preferences
and past experiences form an important risk factor in which to frame the
problem, and social influence also affects the individual’s perception.
One view asserts that single people are more risk tolerant than married
individuals because they have less responsibilities than married people,
particularly in respect to dependents, and face less social risk (that is, potential
loss of esteem) when undertaking risky investments (Roszkowski et al., 1993,
Grable, 2000; Frijns et al., 2008), occupation, income (Grable, 2000; Hallahan et al.,
2003; Hallahan et al., 2004; Veld and Veld-Merkoulova, 2008), may influence a
individual’s level of risk taking and risk-tolerance in portfolio choice. Because of
each individual investor might be influenced by psychology factor for their
investment decision (Veld and Veld-Merkoulova, 2008).
Overconfidence and optimism are further forms of bias. De Bondt (1993)
found that individuals rely on their personal past experience as a foundation and
it is from this that excessive self-confidence in decision-making can originate.
Such investors make inappropriate decisions with insufficient information due to
this personal trait (Shefrin and Statman, 1994). In addition to Overconfidence
bias, optimism is an Achilles heel leading to investment losses. Individuals with
this failing often feel they possess an innate talent and in their optimism, over-
rate their own assessment ability (Kahneman and Riepe, 1998). Having
overconfidence and optimism causes people to further overestimate their own
knowledge, underestimate risk, and it even reduces risk recognition.
Brown et al. suggest to use mutual fund flows as a measure for investor
sentiment and show that the sentiment index they construct is a priced factor in
the Fama and French (1993), Jegadeesh and Titman (1993, 2001) asset pricing
framework. The incremental explanatory power of these fund flows opens,
however, inevitably the debate on the underlying trading behavior.
(Haliassos and Bertaut, 1995; Sung and Hanna, 1996) It is found that
individual investors with university or college education are more likely to
invest in risky asset. The level of education is thought to impact on a person’s
ability to accept risk. Specifically, higher attained levels of education are felt to
increase a person’s ability to evaluate risk and are therefore considered to be
positively related to higher financial risk tolerance
Insufficient acknowledgement of ‘rival rationalities’ (differences in
perceived realities between laypeople and experts) jeopardizes risk dialogues
between these groups. Experts working from technical orientations are likely to
produce information judged too complex, irrelevant or uninteresting by
laypeople, who may be distrusting of experts or scientific expertise given
questions about how well the public interest is being served (Margolis 1996:
Gutteling & Kuttschreuter 2002: 37).
Trading assets are regularly associated with speculative purposes (Young
(1996)) and stocks are probably the most prominent financial instrument used for
speculative investments (Trombley (2003)). Investors might therefore easily
neglect that the financial instruments most widely used for speculative
investments so that the overall probability of a company’s engagement in stocks
is still relatively small if a trading asset is presented.
Consistent with the risk-as-feelings hypothesis by Hsee and Weber (1997)
and Loewenstein et al. (2001), perceptions of asset risk were more strongly
influenced by manipulations known to influence respondents’ emotional
reactions, whereas judgments of future asset volatility were more strongly
influenced by variables known to influence respondents’ cognitive reactions.
Roszkowski (1998) noted that calculating individual investor’s level of
risk perception is a difficult process because risk tolerance is an elusive,
ambiguous concept. Many authors have suggested that risk taking is constant
across situations, but evidence indicates that, for instance, a individual investor’s
level of risk tolerance for physical activities is not a suit gauge of risk taking in
financial situations (Roszkowski, 1998; Rowland, 1996). it has been suggested
that married individuals have greater risk taking propensities because of a
greater capacity to absorb unfavourable outcomes than unmarried person
(Grable, 1999; Grable, 2000).
Benartzi and Thaler (1998, 2001) illustrate that investors have ill-formed
preferences about their investments, which again is consistent with the idea that
preferences are constructed (Slovic, 1995).
There are some empirical evidence showing the impact of risk perception;
risk tolerance and socio-economic on portfolio choice, for instance, Carducci and
Wong (1998), Grable and Joo (1997), Grable and Lytton (1999), Grable (2000),
Hallahan et al., (2003), Hallahan et al., (2004), Frijns et al., (2008), and Veld and
Veld-Merkoulova (2008). In terms of different risk perception or risk tolerance
level, individual investor may show different reaction base upon their
psychology factor and economic situation, which would lead to heterogeneous
portfolio choice for individual investors. For this reason, it is crucial to recognize
and attitudinal how individual investors with different risk perceptions and risk
tolerance make their invest products choice on investment plan, in particular
socio-economic status differentials may make their choice vary and difference.
Marston and Craven (1998) investigated the beliefs that fund managers
and stock analysts assume a short-term time horizon when making or providing
advice on investment decisions.
The existence of common factors in the behavior of mutual fund investors
has recently motivated researchers to capture market sentiment by mutual fund
flows variations and since a couple of years this has become a very popular
research field. Goetzmann et al. (1999) were among the first to empirically assess
the role played by behavioral factors, such as market sentiment, in the variation
of mutual fund flows.
Risk perceptions for individual investors are explored by experimental
design on their potential concepts about risk exposures. Some authors indicate
that investment decision is determined by financial risk taking (Grable et al.,
1999) and risk tolerance (Veld and Veld-Merkoulova, 2008). Hence, identifying
key factors influencing portfolio choice for individual investors is of importance,
particular in the role of risk perception (Grable et al., 1999; Hallahan et al., 2004).
The main contribution of this paper is to recognize the relationship among
portfolio choice, socio-economic factors, risk perceptions and risk tolerance and
asset management institution for individual investor by measuring the risk
perception and risk tolerance of individual investor for portfolio choice. Financial
risk tolerance, reflecting a person’s attitude towards taking on risk, is a complex
psychological concept. However, because of the complexity of the attitudinal
construct, a sophisticated psychological testing instrument is required to
elucidate a person’s attitude to financial risk. Psychometrics is that area of
psychology dealing with the design and analysis of measurements of human
characteristics. Financial risk tolerance is a term widely used in the personal
financial planning industry to refer to an investor’s attitude towards risk. It can
be defined as the amount of uncertainty or making a financial decision.
Identifying key factors influencing portfolio choice for individual
investors is of importance, particular in the role of risk perception (Grable et al.,
1999; Hallahan et al., 2004).
Economic beliefs and attitudes play a major role in modern life. Whereas
attitudes toward money have been fairly well investigated, research is scant on
the perception of economic risks. It is of particular interest to investigate financial
risk perception as contemporary economies expose the individual to personal
risks that were traditionally managed collectively or institutionally (Lunt, 1999).
This means that there is an increasing tendency to shift financial risks onto the
individual who consequently has to manage more complex and uncertain issues
pertaining to money.
Like Coakes & Fisher (2000), Wejnert (2002) states that an individual’s
familiarity with a particular innovation influences how an individual will
perceive the risk of that innovation. Since people are more cautious when it
comes to novelty, the rate of adoption tends to increase as novelty decreases.
People who are more self-confident are less likely to wait and see how others
have gone before taking up the innovative practice (Wejnert 2002; Dalgleish &
White 2001)
The advocates of the efficient market theory argue that it is futile to
practice or to apply certain investment techniques or styles since all investors’
expertise and prospects are already revealed either in a specific stock price or the
overall financial market. Therefore, it is unrealistic for investors to spend their
valuable time and money in order to attempt to outperform the market as
suggested by Ricciardi and Simon (2000) and Ricciardi and Simon (October,
2000).
More recent studies of have investigated psychological factors affecting
both risk perception and the actual investment decisions. MacGregor, Slovic,
Dreman & Berry (2000) showed that imagery (images) and affect influence
financial judgment when investors evaluate stocks in different industries. In
particular, affective ratings (e.g., good-bad and strong-weak) predicted
anticipated industry-sector returns as well as the probability of buying an initial
public offering within an industry sector. Olsen (1997) revealed that the
perceptions of financial risk of both experts (chartered financial analysts) and
non-experts (individual investors actively managing their personal portfolios) is
multidimensional and includes four factors: potential for large loss, potential for
below-target returns, the feeling of control, and the level of knowledge about an
investment. The only difference between the two groups was the sensitivity of
non-professional investors to the potential for large loss.
In contrast to the Investors’ Intelligence of New Rochelle sentiment index
utilized in Lee et al. (2002), we make use of daily mutual fund flow data, which
has the advantage that it offers a unique picture on investors’ portfolio
rebalancing and trading behavior.
Slovic and Weber (2002) have pointed out that while the management of
extreme events will surely look to risk assessment for guidance, the development
of policy is a political enterprise involving for example choices that must
recognize the distinctions between public perceptions of risk in comparison to
technical risk estimates. Equally important, these judgments need to consider
how people would make tradeoffs to reduce risks and consequences and the
public’s level of trust in the mechanisms selected to manage and respond to risk.
Whatever measured for the purpose of self-assessment or for
documentation of investment suitability, financial risk perception is assumed to
be a fundamental issue underlying a number of financial decisions. Because of
those reasons, researchers have been interested in understanding why the
internal factors and externals factors will interact and influence individual
investor’s invest decision. Moreover, it is noteworthy that socio-economic status
does play an important and differential role on risk-taking and risk perception
based on previous research, indicating that factors such as gender (Hallahan et
al., 2003; Hallahan et al., 2004; Veld and Veld-Merkoulova, 2008), age (Bakshi and
Chen, 1994; Brown, 1990; Dahlback, 1991; Mclnish, 1982; Morin and Suarez, 1983;
Palsson, 1996; Veld and Veld-Merkoulova, 2008), marital status has also been
postulated to impact on financial risk perception; however, the exact nature of
the relationship is not clear. One view asserts that single people are more risk
tolerant than married individuals because they have less responsibilities than
married people, particularly in respect to dependents, and face less social risk
(that is, potential loss of esteem) when undertaking risky investments
(Roszkowski et al., 1993, Grable, 2000; Frijns et al., 2008), occupation, income
(Grable, 2000; Hallahan et al., 2003; Hallahan et al., 2004; Veld and Veld-
Merkoulova, 2008), may influence a individual’s level of risk taking and risk-
tolerance in portfolio choice. Because of each individual investor might be
influenced by psychology factor for their investment decision (Veld and Veld-
Merkoulova, 2008).
Kaniel et al. (2004) analyze individual investors’ orders executed on the
NYSE. They find that the trading of individuals is a market wide predictor of
stock returns. Stocks for which individuals show an increased interest for one
week show an average excess return of 1.4 per cent for the following 20 days.
However, the effect seems to be asymmetric, stocks excessively sold by
individual investors do not perform worse than average in the following 20 days.
Koonce, Lipe, & McAnally (2005) and Koonce, McAnally, & Mercer (2005)
suggest that individual judgment is based on behavioural risk dimensions as
identified by Slovic (1987). Those dimensions, Unknown and Dread, capture
notions of familiarity with a risk and possible consequences of this risk,
respectively (Hodder, Koonce, & McAnally (2001)). They translate into
behavioural variables such as an investor’s prior knowledge about a risk or
controllability, observability and immediacy of potentially catastrophic effects of
a risk on one’s own welfare.
In the context of investment advice for individual investors, financial
institutions have used so-called risk profiles for their clients. Risk profiles used
by different banks in different countries all have in common that they investigate
both the time horizon of the investors and on their risk perceptions (Veld and
Veld-Merkoulova, 2008).
Ronay and Kim (2006) have pointed out that there is no difference in risk
attitude between individuals of different gender, but between groups of such,
males indicate a stronger inclination to risk tolerance. That is, no gender
difference was found at an individual level, but in groups, males expressed a
stronger pro-risk position than females.
Portfolio choice is the core investment decision for individual investor
who tries to avoid money loss and to gain return on their investment plan (Veld
and Veld- Merkoulova, 2008; Frijns et al., 2008).
2.7 GAP IN LITERATURE
The present study is an attempt to measure the investor mindset
concerning risk perception in risky investment avenues. Few studies have been
made and indirectly helpful to this research.
The review of previous studies states that perceptions and responses to
risk are common across a range of groups in society and range of financial
products in the society but the demographic point is not an even one in the entire
locale. The investor’s satisfaction depends upon of the trust and dependence that
he places with the financial concern and financial advisors.
The review of previous empirical evidences deal with some research
questions such as, although the individual experts uses their expertise skills and
diligence while investments but still why the dissatisfaction prevail among the
investors and should a financial expert known about the investment risk in the
newest circumstances. A necessary challenge will be to facilitate adequate
coordination across research communities to fill these research gaps. In the
changed scenario, it becomes all the more important to examine if the investor
has been shown that information in the footnotes it receives considerably less
attention than information in the balance sheet or the profit and loss statement.
This will be alleviating when studying the investor risk perception with different
possibilities.

Risk Perception in Investment: A Historical Literature Review

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Risk Perception in Investment: A Historical Literature Review

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CHAPTER II

history of risk perception perspective was derived then investment risk

and ULIPs has been reviewed.

2.1 HISTORY OF RISK PERCEPTION PERSPECTIVE

1973 Payne of Duke university in Florida observed that the observed

correlation between return distribution moments and risk perceptions is

of realizing a return below some target or aspiration level.

1973 Gooding a financial scholar has provided an extensive discussion of

perception from a behavioral perspective was on the subject of investor

perception. While only a few economists have addressed the notion of

perception in a substantial manner in works by Schwartz (1987), Schwartz

marketing literature. Researchers generally agree that perceived risk is a

combination of the perception of the likelihood that something will go

wrong and the perception of the seriousness of the consequences if it

based on past returns, fundamental analysis, present hunches, and all

other information that analysts believe to be germane.

models suggested that perceived risk might be measured by return

distribution moments such as variance and skewness.

judgment, decision making, and risk analysis argued that Public

perceptions are often influenced by risks that have a particularly

catastrophic downside, however small, or which have had a high profile:

“discussion of a low-probability hazard may increase its memorability

and imaginability and hence its perceived riskiness, regardless of what

the evidence indicates”.

are asked, in various ways, to characterize and evaluate hazardous

activities and technologies. Improving methods for eliciting opinions

about risk and providing a basis for understanding and anticipating

common across a range of groups in society as suggested earlier, it

community about acceptable risks

unpredictability of outcomes, knowledge or familiarity, and affective or

emotional reactions (Slovic, Fischhoff, & Lichtenstein, 1985).

1986 MacCrimmon and Wehrung from the field of management define

possibility of loss, and 3) the exposure to loss. Perceived risk is a person’s

opinion (viewpoint) of the likelihood of risk (the potential of exposure to

loss, danger or harm) associated with engaging in a specific activity.

attention and that risks are therefore “exaggerated or minimized

according to the social, cultural, and moral acceptability of the underlying

1988 Kasperson et al., explained, Public reaction may indeed be influenced by

initial perceptions of risk but these perceptions will in turn be affected by

how a community has prepared for and is currently responding to such a

to buy. After all, as perceived risk of purchasing decreases, consumers’

willingness to buy increases.

1990 Monroe observed that perceived benefits are a combination of different

attributes of products (tangible and intangible; intrinsic and extrinsic etc.),

available in relation to a particular buy and use situation. Perceived

sacrifices are a combination of a nominal price and all other costs of

product acquisition and its use.

likelihood of risk (the potential of exposure to loss, danger or harm)

associated with engaging in a specific activity. He provided a key

summary of findings in which perceived risk is a function of the

i. Intuitive heuristics, such as availability, anchoring, overconfidence,

ii. Perceived average losses over time;

iii. Situational characteristics of the risk or the consequences of the risk

iv. Associations with the risk sources;

v. Credibility and trust in risk-handling institutions and agencies;

vi. Media coverage (social amplification of risk-related information);

vii. Judgment of others (reference groups); and

viii. Personal experiences with risk (familiarity). (p. 4)

1992 Kahneman,Tversky, march and Shapira expressed that Individuals are

subject to framing effects, which may tend to focus their attention on

perceived risk dimensions

and it is determined from the questions investors ask, their familiarity