The concept of risk propensity has been the subject of both theoretical and empirical investigation, but with little consensus about its definition and measurement. To address this need, a new scale assessing overall risk propensity in terms of reported frequency of risk behaviours in six domains was developed and applied: recreation, health, career, finance, safety and social. The paper describes the properties of the scale and its correlates: demographic variables, biographical self‐reports, and the NEO PI‐R, a Five Factor personality inventory (N = 2041). There are three main results. First, risk propensity has clear links with age and sex, and with objective measures of career‐related risk taking (changing jobs and setting up a business). Second, the data show risk propensity to be strongly rooted in personality. A clear Big Five pattern emerges for overall risk propensity, combining high extraversion and openness with low neuroticism, agreeableness, and conscientiousness. At the subscale level, sensa...

Personality and domain-specific risk taking

We measure the degree of overconfidence in judgment (in the form of miscalibration, i.e., the tendency to overestimate the precision of one’s information) and self-monitoring (a form of attentiveness to social cues) of 245 participants and also observe their behaviour in an experimental financial market under asymmetric information. Miscalibrated traders, underestimating the conditional uncertainty about the asset value, are expected to be especially vulnerable to the winner’s curse. High self-monitors are expected to behave strategically and achieve superior results. Our empirical results show that miscalibration reduces and self-monitoring enhances trading performance. The effect of the psychological variables is strong for men but non-existent for women.

/pdf/judgemental-overconfidence-self-monitoring-and-trading-4lpqn4bfss.pdf

Judgemental Overconfidence, Self-Monitoring, and Trading Performance in an Experimental Financial Market

This paper offers a whole range of areas in which the latest work on psychology, social psychology and behavioral finance could offer competitive advantage both to financial markets as well as individual firms. The aim is to identify potential applications of experimental and organizational psychology to improve the efficiency of financial institutions. The focus is on two major areas of application: trading and dealing in currencies, and investment decision-making. The paper reviews the seven deadly sins in individual decision-making showing how the financial decision-maker may fall prey to them. It also suggests how this knowledge can be put to use in improving efficiency in financial strategy, marketing, and human resource management (selection, training, decision-aiding, and control). The paper concludes by identifying important questions for the financial markets to consider if they are serious about improving managerial practices.

The Psychology of Financial Decision-Making: Applications to Trading, Dealing, and Investment Analysis

Behavioral finance studies how subjective behavioral elements introduce distortions in the individual’s decision-making process. The empirical study of systematic errors in cognitive reasoning and perception, and ultimately what these errors reveal about the individual’s underlying thought processes, is often referred to as investor heuristics and biases. This paper investigates the cognitive biases and heuristics to which business students are subject. This was achieved by administering a questionnaire and collecting empirical evidence about both undergraduate and graduate business students’ own perceptions of bias. The psychological phenomenon known as bias and its presence in human decision making, both financial and nonfinancial will provide additional insight on the subject of investor irrationality and broaden the ideals of rationality assumed in classical financial theory.

Behavioral Bias within the Decision Making Process

This paper discusses different aspects of the notion of systemic risk. It contains a selective survey of the research on related topics, a review of some case studies of financial crises and failures, and a discussion pointing toward the importance of moral hazard as a key element of systemic risk. The main ideas studied are the links between capital structure theory and bank capital regulation, and moral hazard and agency theory at the level of the individual trader, the financial firm, and the overall financial system. Another important idea is the codetermination of asset prices and bank solvency. My main focus is on moral hazard as a potentially fruitful area for future research. Although existing research emphasizes the powerful propagation mechanisms whereby a small initial shock can be amplified by the financial system, I suggest that moral hazard, together with leverage at the level of the individual firm, can cause a large shock to the financial system.

/pdf/what-is-systemic-risk-moral-hazard-initial-shocks-and-2w693xsqeh.pdf

What is systemic risk? : moral hazard, initial shocks and propagation

This project commenced in October 1996 funded by the Economic and Social Research Council under its Risk and Human Behaviour Programme1. The first year of the project was spent carrying out an extensive review of the relevant literature and conducting pilot studies. This formed the basis for a research strategy enabling data to be gathered that would add to empirical knowledge about risk behaviour, contribute to theory in organisational science and be useful for the firms involved. The second and third years were spent gathering data sequentially at four firms, writing reports for each organisation and writing papers for conference and journal submission. Two broad areas of theory were drawn upon to develop this research – psychological theory and management theory. Each relevant aspect of theory and previous research is outlined below.

The individual and contextual influences on the market behaviour of finance professionals

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The individual and contextual influences on the market behaviour of finance professionals