A Comparison of Financial Risk-Tolerance Assessment Methods in Predicting Subsequent Risk Tolerance and Future Portfolio Choices

Abstract

This study explores the effectiveness of various methods for measuring risk tolerance, with the aim to better understand the risk-taking attitudes and behaviors of financial decision-makers. Using data collected between October 2020 and March 2021, the research investigates three key areas: (a) the stability of risk tolerance over a six-month period, (b) the individual and household characteristics that predict future risk tolerance, and (c) the predictive accuracy of various risk-tolerance assessment methods in relation to portfolio choices made by financial decision-makers. The results show that risk-tolerance scores derived from a psychometrically developed scale provide the most accurate insights into future risk-taking attitudes and portfolio decisions. For those looking for a simple way to assess both current and future risk tolerance and portfolio choices, a stated-preference item can be effective. Although less consistent, a revealed-preference test can also be used to predict risk tolerance and risk-taking behavior. Findings provide guidance for financial decision-makers and financial advisors by comparing the key features of the three primary risk-tolerance assessment methods evaluated in this study. The study also establishes a foundational basis for selecting the most appropriate evaluation approach, based on the variables identified in the findings.

Keywords

• financial risk tolerance
• propensity measures
• stated preferences
• revealed preferences