Academic journal article IUP Journal of Applied Finance

Does Personality Affect Personal Financial Risk Tolerance Behavior?

Academic journal article IUP Journal of Applied Finance

Does Personality Affect Personal Financial Risk Tolerance Behavior?

Article excerpt

Introduction

Personal financial risk tolerance is an important concept with many practical implications in everyday money matters. For an investor, understanding one's risk tolerance level helps to determine the appropriate risk and return parameters of an investment portfolio so that the investor's investment plan and strategy are sustainable. Understanding one's risk tolerance also helps to clarify the difference between one's willingness and one's capacity to take risk in everyday financial matters such as the amount of auto, property, life, and vacation-protection insurances to purchase. Considering the examples of implications discussed above, it is useful to find out whether one's financial risk tolerance in everyday money matters is associated with one's personality. Understanding the link between one's personality and financial risk tolerance can provide some useful insights into one's behavior in being willing to handle uncertainties in pursuing a goal.

Literature Review

Much research has been done to determine the relationship between demographic variables and financial risk tolerance-gender (Bajtelsmit et al., 1999), age (Palsson, 1996; Hallahan et al., 2003), education level (Grable, 2000), income and wealth levels (Bernheim et al., 2001), and marital status (Roszkowski et al., 1993).

Some research has also been done to determine the link between risk tolerance and different personality traits in different settings-Type A in everyday money matters (Carducci and Wong, 1998), Myers-Briggs Type Indicator and investment behavior (Filbeck et al., 2005), risk propensity in different domains, such as sex, additions, outdoor, and others (Nicholson et al., 2005; and Chauvin et al., 2007). Schaninger (1976) found apositive relationship between risk and anxiety measures, and that the risk was negatively related to self-esteem. According to Soane et al. (2010), personality had a direct effect on risky choice behavior in four domains (social, ethical, gambling and recreation), and that perceived costs and benefits mediated the relations between personality and risk-taking. Chitra and Sreedevi (2011) found that personality traits had an impact on the choice of investment method, and that the personality impact was stronger than that of demographic variables.

Very little research was done to assess the relationship between financial risk tolerance and the personality dimensions of extraversion, conscientiousness, agreeableness, emotional stability, and openness with regard to personal money matters. This study, therefore, attempts to fill this gap by determining the impact of the five personality dimensions on personal financial risk tolerance.

Methodology

A questionnaire (see Appendix) was used to collect data from university students of psychology and finance classes. The questionnaire comprised two sections: the first section contained 12 financial risk tolerance assessment questions from which the financial risk tolerance score was derived. The respondents were asked what they would do in different risk scenarios on a 9-point scale (Likert Scale ranging from Extremely Accurate (9) to Extremely Inaccurate (1) was used for the study). A financial risk tolerance score for each respondent was then computed by taking the average of the scores obtained from the respondent's responses to the 12 scenario-based questions. The second section of the questionnaire contained 40 Big Five personality mini-markers developed by Saucier (1994). The personality mini-markers were also structured on a 9-point scale. The questionnaire was filled online by students who were given extra credit points for participating, and the grade incentive minimized any self- reporting bias because almost all the invited students participated, giving us a sample of 331 respondents.

Regression was performed to determine as to which variables contributed to the prediction of risk tolerance and the direction and extent of such contribution. …

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