Measuring financial risk tolerance: from key determinants of change over time to practical applications

Abstract

For financial institutions, the assessment of risk tolerance is a crucial step for an effective and reliable customer profiling, however, its evaluation is not straightforward. A deeper analysis is essential precisely because the way in which risk attitude shapes, evolves and is measured may be considered from distinct points of view which are sometimes conflicting and sometimes converging. A central aspect of the discussion is related to whether this propensity is constant or if it changes over the lifetime, in particular after experiencing specific life events. The first part of this study investigates the different theories about the definition of risk tolerance and about which is the proper measurement tool to evaluate it. Subsequently, its socioeconomic and psychological determinants are examined, along with some life events whose impact may cause a variation in risk propensity. Finally, an empirical analysis aims to understand how to structure a proper survey to effectively determine customers’ financial risk attitude. In particular, an already existing questionnaire is compared with a new one, where questions have been refined and adapted consistently with the findings of this study.