A recently published article in the Journal of Banking & Finance reports on a large-scale implementation to quantitatively assess various aspects of investor’s risk preferences. Traditional assessments typically rely on risk-return preferences. Loss aversion, where people feel losses more intensely than gains, is increasingly recognized as a critical factor in investor behavior.
The authors Dennie van Dolder and Jurgen Vandenbroucke conducted a study to measure loss aversion among 1,040 employees and 3,740 clients of a major financial institution. The study aims to validate a method that can be integrated into financial advisory processes to improve client risk classification by incorporating loss aversion.
Key Findings
- Independence of Loss Aversion from Risk Preferences: The study finds that loss aversion is independent of traditional risk-return preferences. This suggests that simply assessing risk tolerance does not capture the complete picture of an investor’s behavior.
- Correlation with Demographics: The study confirms established findings, such as the level of education being positively correlated with loss aversion, while traditional risk aversion is more closely related to gender, age, and financial status. For example, women, older individuals, and those less financially secure showed higher risk aversion.
- Practical Integration: The study demonstrates how loss aversion can be easily integrated into existing digital advisory processes. Clients responded positively to these enhanced risk profiles, showing higher acceptance rates than traditional methods that do not factor in loss aversion.
Implications for financial advice
- Financial institutions can enhance client profiling by incorporating loss aversion and providing more tailored advice that reflects rational risk preferences and emotional responses to losses.
- The study suggests that measuring risk and loss aversion offers a more comprehensive understanding of investor intent, which could lead to better client satisfaction and investment outcomes.
This research supports the growing movement toward behavioral finance in client profiling. This is also highlighted by how regulators encourage financial institutions to integrate behavioral factors like loss aversion into client risk profiling. By integrating loss aversion into risk assessments, financial advisors can offer more accurate, personalized investment strategies that align with investor behavior’s rational and emotional dimensions.
About the authors:
Dennie van Dolder, Senior Lecturer (Associate Professor) in Economics at the University of Essex
Jurgen Vandenbroucke, PhD, Managing director, everyoneINVESTED , the wealth tech spin-off of KBC Group, Expert general manager at KBC Group, Lecturer in financial engineering at the University of Antwerp, Lecturer in digital household finance at KU Leuven
