Files
Abstract
The research objective of this dissertation was first to associate the concept of risk tolerance typically used by financial planners in research and practice to the concept of risk aversion used by economists by introducing a new measure of investor risk aversion. The research accomplished this by designing a direct risk questionnaire of risk aversion and by developing a mathematical transformation procedure used to convert responses to certainty equivalent amounts and to coefficients of relative risk aversion (gamma coefficients) in a way that matches theory related to constant relative risk aversion (CRRA). The single-item question combines elements from revealed preference and propensity measurement techniques in a way that matches traditional CRRA estimation procedures. The new measure was validated using propensity measures, revealed preference methodologies and other well-established measures of risk tolerance and risk aversion measurements (such as the Survey of Consumer Finances (SCF) risk aversion item) that are widely used in financial planning research and practice. The research confirmed the concurrent and construct validity of both the transformation procedure and the proposed new measure of risk aversion using a combination of correlational and regression tests. Based on survey data from 500 investors living in the United States, scores from the proposed measure were found to correlate with other measures of risk aversion, as well as with indicators of risk taking. The results show the new direct measure can be used to identify the appropriate risk-aversion level for an investor and the resulting gamma coefficients were used to estimate the decision-maker’s expected utility, certainty equivalent for any gamble or financial risk and overall, as descriptors of financial investor’s behavior. These finding were also used to demonstrate/illustrate the use of gamma coefficients obtained from the proposed measure in the context of Modern Portfolio Theory and its applications.