Academic journal article IUP Journal of Applied Finance

Influence of Urgency on Financial Risk-Taking Behavior of Individual Investors: The Role of Financial Risk Tolerance as a Mediating Factor

Academic journal article IUP Journal of Applied Finance

Influence of Urgency on Financial Risk-Taking Behavior of Individual Investors: The Role of Financial Risk Tolerance as a Mediating Factor

Article excerpt

Introduction

For centuries it has been identified that an individual's psychological disposition influences his decision making in general and risk-taking behavior in particular (Schwarz and Clore, 1996; Bagozzi et al., 1999; Mellers et al., 1999; Lerner and Keltner, 2000; Luomala and Laaksonen, 2000; Lerner et al., 2004; Slovic et al., 2004; and Han et al., 2007). There is yet no consensus amongst the researchers regarding the role these psychological dispositions play in the way in which individuals exhibit financial-risk taking behavior (Clarke and Statman, 1998; Ackert et al., 2003; and Olson, 2006).

Researchers have been examining the influence of dispositions on the individual's perception towards risk (Johnson and Tversky, 1983) and their risk-taking behavior (Hockey et al. 2000; and Hirshleifer and Shumway, 2003). They were of the opinion that both cognitive and affective states influence an individual's risk-taking behavior (Schunk and Betsch, 2006; Townsend, 2006; and Wang, 2006); however, they were quite contradictory in their predictions while conceptualizing the role played by specific affective states, as results were inconsistent.

Although a large number of conceptual frameworks were based on behavioral observations (e.g., Prospect Theory, Regret Theory, Ellsberg's Paradox, Satisficing Theory), risk-as-feelings hypothesis offered a fresh approach to understand both risk tolerance and risk-taking behaviors. The framework proposed by Loewenstein et al. (2001) combined both the rational and experiential systems and was based on the presumption that responses to risky situations (including decision making) result in part from direct emotional influences, suggesting that an individual assesses risky situation using both cognitive (based on subjective evaluation) and affective (based on disposing factors) processes. The framework was in consistent with the findings of Slovic et al. (2004) which stated that, "affect influences judgment directly and is not simply a response to a prior analytic evaluation".

Decisions which are influenced by affective state tend to be easier, faster, and often more efficient than those made by a rational approach. It does not mean that experiential decision systems which are based on affect will always lead to ideal financial risk-taking behavior, but it is possible that a person's affective state can cause short-term myopic decisions that do not account for later changes in emotions and circumstances.

Until now, the researches have been based on the traditional economic utility approach. However, the theory did not adequately elucidate individual's financial attitudes and behaviors when they were asked same but differently framed questions about similar payoffs (Slovic et al., 2004). Also, it has been noticed that the role played by affective states in influencing risk-taking behavior is rarely studied within the economic utility frameworks.

The specific role of urgency being an affective state has received limited attention within the field of personal and consumer finance literature. In general, there is lack of evidence to state that urgency is related to an individual's risk-taking behavior and if it does, it is not clear what direction it will take. Hence, an apparent need exists to study the influence of urgency on risk-taking behavior. Since nearly all studies to date have addressed the impact of negative urgency but relatively few studies have addressed the impact of positive urgency on risk taking, this paper tries to further examine the effects of a positive urgency combined with negative one on risk taking. Moreover, the mediating effect of financial risk tolerance will be explored to identify the causal relationship, if any, between the urgency and risk-taking behavior of individuals engaged in day-to-day financial decision-making situations.

Literature Review

Financial Risk-Taking Behavior

The study is based on the concept of measuring risky financial behavior comprising money mismanagement outcomes like salary deduction, overdue notices from creditors, selling all of investments instantaneously or at a discount. …

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