An Empirical Study on Objective and Subjective Financial Risk Tolerance: Moderated Mediation of Financial Literacy and Personality Types

Abstract

Nowadays, investors are increasingly responsible of their own financial future. Pension policies shifted to contribution base, financial markets around the world have become more and more accessible to small investors, and financial education programs have become progressively more popular to help investors navigate the ever so complex financial world. Since making financial decisions of paramount importance has become nearly impossible to avoid or delegate, the need to provide a measure of a person’s maximum amount of uncertainty that someone is willing to accept when making a financial decision turned to be crucial. This measure is called Financial Risk Tolerance. Several tools exist to measure it in practice, and despite the pros and cons of various methodologies, there is complete agreement among investment advisers, researchers, and policy makers that financial risk tolerance is the major factor in portfolio allocation, wealth accumulation, and retirement preparedness. In this study, financial risk tolerance is assessed both at objective and subjective level. Objective risk tolerance is measured with the Grable and Lytton 13-item scale, while subjective risk tolerance is measured with a self-assessment question as used in previous research and on the American Survey of Consumer Finances (SCF). Without knowledge, the individual is oblivious of her risk tolerance level. Without perception and awareness, the individual does not have the confidence to behave genuinely in accordance with her risk tolerance levels. The first goal of this research is to investigate the relationship between subjective and objective risk tolerance. Existing research has shown that several demographics, socioeconomic, and attitudinal factors affect risk tolerance, and it is necessary to examine these relationships in more detail. This research contributes to previous studies by focusing on demographics, financial literacy, and personality types. For decades, many scholars have agreed that demographic variables are the determinants of financial risk tolerance. Additionally, numerous studies have provided essential findings on the importance of financial literacy and this factor has been widely recognized as an important element determining the financial decision-making competencies for individual investors. Lastly, more recent studies introduced a psychological factor such as the personality traits to the research on financial risk tolerance. The second goal of this study is to investigate the role of financial literacy and personalities as factors affecting the relationship between subjective and objective risk tolerance. Data is collected through an online questionnaire. The questionnaire is based on previous literature, by combining instruments from several published studies and existing surveys. The goal is to test the empirical role of financial literacy and personality types. To reach a wide number of respondents, the link to the questionnaire is shared through social media with the cooperation of few influencers.