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Victor Ricciardi
Preliminary Version:
July 20, 2004
Note: Please do not “direct quote” any material from this document without first
contacting the author for permission since this is a preliminary draft.
Thanks for your cooperation.
Acknowledgments: The author would like to thank the following individuals for their insightful comments
and support: John Courtis, Robert Olsen, Doug Rice, Hugh Schwartz, Hersh Shefrin, Paul Slovic, Igor
Tomic, Carol Watson and Arnold Wood. The paper was presented at the Society for the Advancement of
Behavioral Economics/ International Association for Research in Economic Psychology conference, July
15-18, 2004 in Philadelphia, Pennsylvania, U.S.A. I would like to thank the members of SABE/IAREP for
their helpful questions and suggestions during my presentation. This paper is based on the author’s
dissertation “A behavioral finance study: An investigation of the perceived risk for common stocks by
investment professionals (financial analysts vs. financial planners)” at Golden Gate University in San
Francisco, California.
Within the last section of this paper, the author reveals the first of its kind thorough review of the
academic research studies on perceived risk/risk perception from the disciplines of behavioral
accounting since 1975 and behavioral finance since the late 1960s. This literature review
incorporates 12 works from behavioral accounting and 71 endeavors from behavioral finance. In
addition, the behavioral finance literature review section also includes approximately 10 narrative
research reviews from risk perception studies in behavioral economics. A major facet of this
paper was to bring together all the previous studies in the risk perception literature for the purpose
of conducting a study based on the academic foundation of the main themes, research approaches,
and findings from this collection of studies.
Keywords: risk perception, perceived risk, financial risk indicators, behavioral risk characteristics,
objective risk, subjective risk, behavioral accounting, standard finance, behavioral
finance, psychology, financial psychology
Note: Please do not “direct quote” any material from this document without first contacting
the author for permission since this is a preliminary draft.
Thanks for your cooperation.
Risk incorporates a systematic set of prospects and statistical chances that include gains (upside
risk) and losses (downside risk). Lane and Quack (1999) provide the following perspective of risk:
A dictionary definition of risk is that of a state in which the number of possible
future events exceeds the number of actually occurring events, and some measure
From the area of finance, Markowitz (1952) first proposed that investment portfolios could be
evaluated in terms of their expected return and the riskiness of that return. Over the years, the
standard definition of risk that developed within academic finance was based on complex
statistics and mathematics, in which risks are narrowed to purely objective measurements and
figures. Haslem (2003) provided an extended application of the widely accepted view of
academic finance:
Risk is the other side of return. Returns comprise two elements, the periodic
payment of interest or dividends (yield) and change in asset values over a period
of time (capital gains/losses). The capital asset pricing model (CAPM) posits that
return and risk are positively related – higher return carries higher risk. (p.167)
Bernoulli in 1738 published his historic paper “Exposition of a New Theory on the Measurement of
Risk” argued that investors do exclusively value financial assets based on the expected return. Since
Bernoulli’s celebrated examination, this other aspect of asset pricing has become known as
investment risk (Gooding 1976). Modern portfolio theory defines risk as a variation of return,
rather than a danger, hazard or the probability of failure. According to standard finance, risk is
evaluated and measured based upon variations of actual returns of an investment from its expected
return. In standard finance, the basic definition of risk pertains to both “sides of the coin” namely an
upside risk in which returns are higher than expected as well as a downside risk in which the
probability of earning less than the expected return (i.e. the greater the chance of low or negative
returns, the riskier the investment). The two main measures of this type are 1) standard deviation,
The Nobel Prize was awarded in 1990 to Markowitz for the formation of modern portfolio theory
and Sharpe for the development of the Capital Asset Pricing Model (Ricciardi and Simon,
October 2000). The theoretical basis for investigating the relationship between risk and return
was developed in a context known as the Capital Asset Pricing Model (CAPM) in studies by
Sharpe (1964), Lintner (1965b) and Mossin (1966). This model is based on a theory and
approach for measuring any financial decision where investment funds are allocated with the
objective of earning future profits. In effect, “The CAPM is a mathematical model that attempts
to explain how securities should be priced, based on their relative riskiness in combination with
the return on risk-free assets” (Ricciardi and Simon, October, 2000, p.3). Sharpe published his
paper “Capital Asset Prices: A Theory of Market Equilibrium” on the Capital Asset Pricing
Model (CAPM) based on the previous work of Markowitz (1952, 1959).
Sharpe extended Markowitz’s work with the development of the risk-free asset that helped create
portfolio theory and the CAPM. The model was created to describe the behavior of financial
security prices and to provide a method whereby investors can evaluate the influence of a
possible security investment on their portfolio’s risk and return. In general, investment risk is
considered in two separate components: 1) systematic risk inherent in the financial markets such
as economic conditions and government policy changes and 2) non-systematic risk based on
certain company factors such as financial structure (i.e. leverage) and market value measures (i.e.
P/E ratios). Since non-systematic risk is associated with individual firms (stocks) it can usually
be diversified away within large portfolios of holdings, thus in theory it is possible to decrease
non-systematic risk to essentially zero because of sufficient portfolio diversification. In its
simplest forms, the CAPM is a far-reaching theory of risk and return tradeoffs within a perfect
marketplace. Because of the issue of portfolio diversification, the CAPM makes the assumption
Studies questioning the reliability of beta as a risk measure have been established in the late
1960s and early 1970s with the emergence of beta and the development of the CAPM. Arditti
(1967) found that variance and the skewness of the probability distribution of returns were
somewhat sound measurements of risk but beta was not. For instance, Levy (1971) made the
point even though betas are relatively accurate and predictable over a long-term time horizon for
large holdings of financial securities; they are, rather unpredictable for individual financial
instruments (i.e. betas for individual stocks change over time). This is another issue that reveals
problems with utilizing historic betas in forecasting risk into the future. In essence, Levy (1971)
questioned the soundness of employing historic betas for individual financial securities in
building portfolios held in the future.
Over the last thirty years, the validity of historical betas to capture “accurate betas” has been the
focus of intensive debate among financial academics in numerous academic studies by Black,
Jensen & Scholes (1972), Fama and MacBeth (1973), Roll (1977), Wallace (1980), Lakonishok and
Shapiro (1986), Markowitz (1990), Frankfurter (1993), Wagner (1994), Malkiel and Xu (1997),
Daniel, Hirshleifer and Teoh (2001) and Bloomfield and Michaely (2002). In particular during the
1990s, the criticism of beta and the CAPM within the financial literature has intensified with the
emergence of behavioral finance. For instance, there has been the discussion of Behavioral Capital
Asset Pricing Theory by Shefrin and Statman (1994), Shefrin and Statman (2000), and Shefrin
(2003) and Behavioral Asset Pricing Model by Ramiah & Davidson (2003). The significant paper
by McGoun “The CAPM: A Nobel Failure” in 1993 revealed the shortcomings and dissatisfaction
of this asset pricing model.
The seminal paper by Fama and French (1992) presented the most detrimental information against
the validity beta and the CAPM. The authors conducted a cross-sectional study and reported that
beta cannot explain the variance of average returns of stocks over the period 1936-1990. They
found that firm size and book-to-market equity are statistically related to expected returns. The
authors revealed that the cross-sectional association between stock returns and market betas are
close to zero (there appeared to be no relationship between the 2 factors). In its place, their findings
show that the natural logarithm (ln) of the market value of equity of a firm, ln(ME), considers the
ability of the company’s beta to explain the return. The authors found the two highly accepted
factors that justified stock returns (i.e. the leverage ratio and the earnings-price ratio), provided low
1976 Thomas Milburn, Decision-Making Perspectives from Psychology: American Behavioral Scientist
Robert Billings Dealing with Risk and Uncertainty
1976 Chauney Starr, Philosophical Basis for Risk Analysis Annual Review of Energy
Richard Rudman,
Chris Whipple
1977 Robert Libby, Behavioral Models of Risk Taking in Business Journal of Accounting Research
Peter Fisburn Decisions: A Survey and Evaluation
1977 Edward Miller Risk, Uncertainty, and Divergence of Opinion The Journal of Finance
1980 Chauney Starr, A Perspective on Health and Safety Risk Analysis Management Science
Chris Whipple
1980 Charles Vlek, Rational and Personal Aspects of Risk Acta Psychologica
Peter-Jan Stallen
1983 Vincent Covello The Perception of Technological Risks: Technological Forecasting and
A Literature Review Social Change
1983 Lola Lopes Some Thoughts on the Psychological Journal of Experimental Psychology;
Concept of Risk Human Perception and Performance
1986 Peter Dickson, Missing the Boat and Sinking Boat: A Journal of Marketing
Joseph Giglierano Conceptual Model of Entrepreneurial Risk
1987 Lola Lopes Between Hope and Fear: The Psychology of Risk Advances in Experimental
Social Psychology
1988 Phipps Arabie Some Current Models for the Perception and Organizational Behavior and
Judgment of Risk Human Decision Processes
1993 Daniel Kahneman, Timid Choices and Bold Forecasts: Management Science
Dan Lovallo A Cognitive Perspective on Risk Taking
1995 Vincent-Wayne Mitchell Organizational Risk Perception and Reduction: British Journal of Management
A Literature Review
1998 Asa Boholm Comparative Studies of Risk Perception: Journal of Risk Research
A Review of Twenty Years of Research
1998 Ortwin Renn Three Decades of Risk Research: Journal of Risk Research
Accomplishments and New Challenges
2001 A. E. Wahlberg The Theoretical Features of Some Current Journal of Risk Research
Approaches to Risk Perception
1976 William Lowrance Of Acceptable Risk: Science and the Classic book on perceived risk
Determination of Safety on hazardous activities from
the social sciences.
1981 The Royal Society The Assessment and Perception of Risk Book of readings on perceived
risk from a 1980 symposium.
1982 Daniel Kahneman, Judgment Under Uncertainty: Many of the topics and principles
Paul Slovic, Heuristics and Biases of this book in behavioral finance
Amos Tversky and decision-making pertain to
the multi-dimensional aspects
of perceived risk.
1983 Vincent Covello, The Analysis of Actual Versus Perceived Collection of research studies
W. Gary Flamm, Risks on perceived from non-financial
Joseph V. Rodricks, areas such as nuclear power and
Robert Tardiff smoking.
1987 W.T. Singleton, Risk and Decisions Book of readings and research
Jan Hovden studies pertaining to decision-
making on risky activities.
1988 Kenneth MacCrimmon, Taking Risks: The Management of Uncertainty Collection of studies on risk-
Donald Wehrung taking behavior of executives.
1993 Paul Anand Foundations of Rational Choice Under Risk This book provides an extensive
overview risk decision-making
under the tenets of rationality.
1994 Rudiger Trimpop The Psychology of Risk Taking Behavior Most extensive review on risk-
taking behavior pertaining to
financial and non-financial
areas originally from the
author’s dissertation.
1995 Zur Shapira Risk Taking: A Managerial Perspective An extensive research study on
the risk taking behavior of
business executives from Israel.
1996 Peter Bernstein Against the Gods: The Remarkable Story of Risk The author provides an extensive
historical perspective of risk.
2000 Glenn Koller Risk Modeling for Determining Value and This follow-up work applies
Decision Making risk modeling within a wide
range of contexts.
2001 Carlo C. Jaeger, Risk, Uncertain, and Rational Action A substantial discussion of
Ortwin Renn risk and uncertainty from a
Eugene A. Rosa, social science perspective.
Thomas Webler
2002 Gerd Gigerenzer Calculated Risks: How to Know When This book provides an interesting
Numbers Deceive You viewpoint of risk and uncertainty
for real world circumstances.
2002 David Ropeik, Risk: A Practical Guide for Deciding This reading provides an overview
George Gray What’s Really Safe and What’s Really of 50 hazardous activities across
Dangerous in the World Around You 3 main categories: 1) home, work, and
transportation; 2) the environment;
3) medicine.
2002 Cass R. Sunstein Risk and Reason: Safety, Law, and the This book provides an extensive
Environment discussion of a wide range of risky
situations and hazardous activities.
Perception is how we become conscious about the world and ourselves in the world. Perception is
fundamental to understanding behavior since this process is the technique by which stimuli affect
an individual. In other words, perception is a method by which individuals organize and interpret
their sensory intuitions in order to give meaning to their environment regarding their awareness of
“events” or “things” rather than simply characteristics or qualities. Perception is a search for the
best explanation of sensory information an individual can arrive at based on a person’s
knowledge and past experience. Sometimes during this perceptual process, illusions can be
intense examples of how an individual might misconstrue information and incorrectly process this
information (Gregory, 2001). Ittelson and Kilpatrick (1951) provided the following viewpoint on
perception:
What is perception? Why do we see what we see, feel what we feel, hear
what we hear? We act in terms of what we perceive; our acts lead to new
perceptions; these lead to new acts, and so on in the incredibility complex
process that constitutes life. Clearly, then an understanding of the process by
which man becomes aware of himself and his world is basic to any adequate
While Morgan and King (1966), elaborate further with their description of perception from the
field of psychology. The authors provide two distinctive definitions of perception:
1) Tough-minded behavioralists, when they use the term at all define perception
as the process of discrimination among stimuli. The idea is if an individual
can perceive differences among stimuli, he will be able to make responses
which show others that he can discriminate among the stimuli…This
definition avoids terms such as experience, and it has a certain appeal because
it applies to what one can measure in an experiment. (p. 341)
The literature seems to have a wide interpretation among the different branches of psychology
(i.e. debate) regarding the exact meaning of the concept of perception according to works by
Allport (1955), Garner, Hake, and Eriksen (1956), Hochberg (1964), Morgan and King (1966),
Schiffman (1976), Bartley (1980), Faust (1984), McBurney and Collings (1984), Cutting, (1987),
Rock, (1990), Rice (1993), and Rock (1995), which is a similar predicament regarding the
different interpretations of risk across various disciplines. Individuals from the area of finance
and investments might want to focus on the basic characteristics of perception, including:
o An individual’s perception is based on their past experience of a similar event,
situation or activity;
o People focus or pay attention to, different components (information) of the same situation;
o A major premise of perception is individuals have the ability to only process a
limited number of facts and pieces of information at a time in order to make a
judgment or decision concerning a certain activity, event, or situation;
o In general, it’s human nature to organize information so we can make sense of it. (We
have a tendency to make new stimuli match with what we already understand and
know about our environment.)
o A stimulus (impulse) that is not received by an individual person has no influence
(effect) on their behavior while, the stimulus they believe to be authentic, even
though factually inaccurate or unreal, will affect it;
o Perception is the process by which each individual senses reality and arrives at a
specific understanding, opinion, or viewpoint;
o What an individual believes he or she perceives may not truly exist;
o A person’s behavior is based on their perception of what reality is, not necessarily on
reality itself; and
o Lastly, perception is an active process of decision making, which results in different people
having rather different, even opposing, views of the same event, situation or activity.
2.3 A Visual Presentation of the Perceptual Process: The Litterer Perception Formation Model
This section on perception will provide a discussion of Litterer’s simple perception formation
model (1965) from the area of organizational behavior in order to provide the reader with a visual
presentation and further explanation of the perceptual decision making process. This model
provides a good application of the previous discussion of perception. The author does not attempt
to discuss the validity of the model. (See Figure 1: The Litterer Perception Formation Model for
further details.) This perception model has been described in substantial detail by Kast and
Rosenzweig (1974) and Kast and Rosenzweig (1985) from the field of management and utilized
by the financial scholar Gooding (1973) in an extensive research study on investor perception.
Litterer’s model provides an illustration regarding how perceptions are produced and thus affects an
individual’s behavior. There are two inputs (external factors) to this perceptual process, which are
information (i.e. financial data) and past experience of the individual (i.e. the decision making
process of the investor). Whereas, the model contains three “mechanisms” of perception formation
that are considered internal factors (developed from within a person) which are selectivity,
interpretation and closure. The notion of selectivity (selective perception) is an individual only
selects specific information from an overwhelming amount of choices that is received (i.e. a method
for contending with information overload). In essence, we can only concentrate on and clearly
perceive only a few stimuli at a time. Other activities or situations are received less visibly, and the
remaining stimuli become secondary information in which we are only partially aware of. During
this stage, a person might unconsciously foresee outcomes, which are positive (i.e. high returns for
their personal investment portfolio). A person may assign a higher than reasonable likelihood of a
specific outcome if it is intensely attractive to he or she. Ultimately, this category of selectivity
may be related to voluntary (conscious) or involuntary (unconscious) behavior since a person my
not make the rational (optimal) decision and instead select from a set of less desirable choices (i.e.
the idea underlying the principles of prospect theory and heuristics). On the other hand, the choices
may not be “less desirable,” at least in some cases. They may be the only feasible ones available
given the circumstances, lack of data or pressure of time.
The purpose of the second mechanism known as interpretation makes the assumption that the same
stimulus (i.e. a specific risky activity or situation) can be understood in a different way among a
number of decision makers. This process of interpretation relies on a person’s past experience and
value system. This mechanism provides a structure for decoding a variety of stimuli since an
individual usually has an inclination to think or act in a certain way regarding a specific situation or
activity. Lastly, the closure mechanism in perception formation concerns the tendency of
individuals to have a “complete picture” of any specified activity or situation. Therefore, an
individual may perceive more than the information appears to reveal. When a person processes the
information, he or she attaches additional information to whatever appears suitable in order to close
the thought process and make it significant. “Closure and interpretation have a feedback to
selectivity and hence affect the functioning of this mechanism in subsequent information
processing” (Kast and Rosenzweig, 1970, p. 218).
Mechanisms
of perception
formation
Interpretation
Perception
Information Selectivity
Closure Behavior
PERCEPTION FORMATION
Source: Modified from Kast F.E. and J.E. Rosenzweig (1970) Organizations and Management - A Systems
Approach, New York: McGraw-Hill.
This section has presented some important principles on the perceptual process that should
hopefully provide an overall enhanced understanding of the notion of perceived risk throughout this
work. This segment has attempted to demonstrate to the reader the complexity of the perceptual
decision-making process from a behavioral viewpoint. The awareness of this perceptual process is
connected directly to how investors process information under the assumptions of behavioral
finance known as bounded rationality, heuristics, cognitive factors, and emotional issues. Thus, the
next section provides an overview of how an investor processes information and the various
behavioral finance issues that might influence a person’s perception of risk within the judgment
process.
Information
Processing:
Cognitive and
Emotional Factors
Relation to Cross-cultural
Statistical data differences
2.5.3 Overconfidence
Overconfidence in decision-making is another factor that influences risk perception since there
are many ways in which people tend to be overconfident about their decisions regarding risk.
Within the behavioral finance literature, overconfidence is one of the most documented biases
according to Daniel and Titman (2000). Confidence can be described as the “belief in oneself and
one’s abilities with full conviction” whereas, “overconfidence can be taken a step further in
which overconfidence takes this self-reliant behavior to an extreme” (Ricciardi and Simon,
October 2000, p. 13). As humans we have an inclination to overestimate our own skills, abilities,
and predictions for success as noted in papers by Ricciardi and Simon (2000), Ricciardi and
Simon (October, 2000), Ricciardi and Simon (2001), and Ricciardi (2003). Myers (1989) further
commented:
Our use of quick and easy heuristics when forming judgments and our bias
toward seeking confirmation rather than refutation of our ideas can give rise to
the overconfidence phenomenon, an overestimation of the accuracy of our
current knowledge. (p.293)
Individuals are very confident in their decisions formed under the cognitive processes of
heuristics and are rather inattentive regarding the exact manner in which their decision was
formed. For instance, Slovic, Fischhoff, and Lichtenstein (1980) had non-expert subjects indicate
the chances that they were correct in selecting the more frequent deadly events. Individuals often
gave answers of 100:1 or more that their assessments were accurate. However, approximately 1 in
8 answers associated with such extreme confidence was erroneous (less than 1 in 100 would have
been incorrect if the chances had been suitable). Also, this overconfident behavior extends to
expert individuals (i.e. safety inspectors) in which, they ignore or underestimate the odds of a
risky event or activity. When experts are required to rely on intuitive judgment, rather than on
statistical data, they are prone to making the same sort of errors that the novices make. The
existence of this overconfident behavior within expert decision-making occurs for several reasons
including: failure to contemplate the way human mistakes influence technological systems,
exhibiting overconfidence in existing scientific knowledge, inattentiveness to how technological
systems perform together as a whole, and failure to predict how people respond to safety
procedures (Slovic, Fischhoff, and Lichtenstein, 1980).
Another category of the overconfidence heuristic is the notion of the “It won’t happen to me”
bias. In this instance, individuals tend to consider themselves invulnerable to specific risky
activities or events on an individual basis, however they would readily concede to these risks on a
societal level. For instance, most individuals have a tendency to believe they are better than the
2.5.5 Representativeness
Another important heuristic that plays a role in affecting a person’s perception of risk is known as
representativeness. Behavioral finance scholars refer to a fundamental mental mechanism that we
set in motion because of abstract rules known as a mental shortcut that is part of the judgment
process was first introduced by Tversky and Kahneman in 1971. “Decision makers manifesting this
heuristic are willing to develop broad, and sometimes very detailed generalizations about a person
or phenomenon based on only a few attributes of the person or phenomenon” (Busenitz, 1999, p.
330). “Many mental shortcuts exist that make it difficult for investors to analyze new information
correctly and without bias” (Ricciardi and Simon, 2001, p. 21). Representativeness reflects the
belief that a member of a category (i.e. risky activity or events) ought to resemble others in the
same class, and that an effect ought to resemble the cause that produced it as noted in Ricciardi and
Simon (2001). In essence,
Representativeness is but one of a number of heuristics that people use to render
complex problems manageable. The concept of representativeness proposes that
humans have an automatic inclination to make judgments based on the similarity
of items, or predict future uncertain events by taking a small portion of data and
drawing a holistic conclusion. (Ricciardi and Simon, 2001, p.21)
2.5.6 Framing
Another factor that influences a person perception of risk is the format in which a situation or
choice is presented is known as framing. Framing issues occur when indistinguishable or
equivalent depictions of outcomes or items result in different final decisions or inclinations.
Kahneman and Tversky (1979) utilized framing effects from two significant perspectives within
the decision-making process including: the environment or context of the decision and the format
in which the question is framed or worded. “Framing is an assessment of level-headedness
(rationality) in making choices and formulating thoughts is whether the same question, presented
in two distinct but equal means, will extract the identical response” (Ricciardi and Simon, 2001,
p. 23). Duchon, Ashmos, and Dunegan commented further on framing:
Decision makers evaluate negative and positive outcomes differently. Their
response to losses is more extreme than their response to gains which suggests,
psychologically, the displeasure of a loss is greater than the pleasure of gaining
the same amount. Thus, decision makers are inclined to take risks in the face of
sure losses, and not take risks in the face of sure gains. (1991, p.15)
2.5.7 Anchoring
Anchoring is “used to explain the strong inclination we all have to latch on to a belief, that may or
may not be truthful, and use it as a reference point for upcoming decisions” (Ricciardi and Simon,
2001, p. 25). Anchoring involves a decision-making process of thought, which people use to
solve intricate problems by selecting an initial reference point and adjusting slowly to a correct
answer that differs from an initial conviction. For instance, “one of the most frequent anchors is a
past event or trend. In attempting to project sales of a product for the coming year, a marketer
often begins by looking at sales volumes for past years. This approach tends to put too much
weight on past history and does not give enough weight to other factors” (Anderson, 1998, p. 94).
Hammond, Keeney, and Raiffa (1998) illustrates an additional example of anchoring in the article
entitled “The Hidden Traps In Decision Making”:
How would you answer these two questions?
Is the population of Turkey greater than 35 million?
What’s your best estimate of Turkey’s population?
In general, the seminal works by the Decision Research scholars utilized factor analysis to
demonstrate that a wide range of risk indicators may be reduced to two main risk constructs or
dimensions for a collection of the standard nine risk behavioral risk characteristics (Fischhoff,
Slovic, Lichtenstein, Read and Comb 1978). The first factor developed was known as “Dread Risk”
in which risks measured as possessing catastrophic potential, the severity of consequences, the risk
to future generations, and the controllability of consequences. The second risk factor was classified
as “Unknown Risk,” and separates out between hazardous activities that are familiar, that have been
around longer, and the have immediate consequences vs. those risky actions that are unfamiliar,
new, and have belated causes. Yates and Stone comment further:
What is most interesting about Factors I (Dread Risk) and II (Unknown Risk) is
that they correspond quite well with two basic constituents of the theoretical risk
concept, loss significance and loss uncertainty, respectively. The analysis
implies that, when people think and communicate about the riskiness of a given
hazard, they really do have in mind those two constructs. (1992, p.76)
5) Write the narrative research review: The author wrote an extensive narrative for each
research endeavor from behavioral accounting and behavioral finance (see Figure 3:
Part 5).
This 5-step approach was applied, revised, and utilized several different times as the scope of this
risk perception endeavor became more concise and focused upon completion of the narrative
research review of the literature.
All of the risk perception studies within this literature review were based on some method of
experimental, exploratory or survey research or a combination of these approaches while employing
a research design that was conducted in either five ways: 1) with a behavioral experiment; 2) an ad-
hoc group (a convenience sample) at a conference, classroom or another venue; 3) a random or
nonrandom sample with a mailed survey; 4) a multi-method approach (a combination of qualitative
and quantitative research); or 5) a random sample with a telephone survey. The research sample for
each study was either one of the following or a combination of groups such as nonexperts (i.e.
students, individual investors) and experts (i.e. professors, investment professionals) or both. The
next two sections provide an individual review for each of the risk perception studies in behavioral
accounting and behavioral finance.
Part 1A: Identified the main search terms: Part 1B: Identified the main research sources:
risk taking behavior, perceived risk, risk Internet searches (www.google.com), working
perception, investor perception, risk papers on the Internet (www.ssrn.com),
preference, risk tolerance, accounting dissertations (Proquest online database), academic
determined risk measures, risk indicators, studies (Proquest, APA, and Uncover online
investment risk, behavioral accounting, database), books/reports (www.amazon.com), the
behavioral finance. literature reviews and reference lists of other
scholars in risk perception since the 1960s from
various disciplines.
1975 1984 1985 1987 1988 1990 1991 1995 1998 2001 2002 2003
(1) (1) (1) (1) (1) (1) (1) (1) (1) (1) (1) (1)
Number of
McDonald Studies per Farrelly Farrelly, Ferris, Viger,
and Year and Levine, and Hiramatsu, and Ben-Amar,
Stehle Reichenstein Reichenstein Kimoto Curtola, and
(75) Author (s) of (84) (87) (90) Anandarjan
Each Study (02)
The major research design that was incorporated for 7 of these studies was a self-administered survey
mailed to a random sample. All of these mailed surveys utilized some form of multivariate statistical
approach such as regression analysis, correlations, intercorrelations or discriminant analysis. The
most dominant method of analysis within these studies was regression analysis in which the
dependent variable was the quantitative respondent data (i.e. the investor’s perception of risk, average
or mean risk perception variable) regressed against the independent variables namely a collection of
accounting risk proxies or financial risk indicators. (Table 5 displays the details with of each study
providing the number of participants, the response rate of the survey, and the investment task). The
other 5 studies utilized ad-hoc groups (i.e. a convenience sample) in either a laboratory experiment or
a nonrandom sample within a classroom setting. (Table 6 shows specifics of each research endeavor
including: the number of subjects and investment task.) Hypothesis testing was not a prevalent
research perspective since it was only employed within two research endeavors. Most of these studies
did not incorporate any behavioral risk characteristics until the work of Koonce, McAnally and
Mercer (2001) based on the work of the Decision Research scholars from psychology. The only
prevalent behavioral issue was the notion of familiarity bias in which an investor’s perception of risk
is influenced by the name of stock (i.e. brand name of the company). Thus, scholars investigated this
issue of familiarity with the implementation of a “split sample” wherein a percentage of surveys
would disclose the name of the firm and the remaining surveys would have the company identity
withheld. Lastly, most of the studies had respondents make a judgment or assessment concerning the
overall perceived riskiness of each stock (i.e. rank the overall risk of this firm on a scale of 1-low risk
The Koonce, McAnally and Mercer (2003) working paper a revised adaptation of the earlier work
by the same authors in 2001. The authors develop a new model of risk perception that
incorporates both behavioral risk characteristics and the standard decision theory (i.e. statistical
probabilities and expected value) pertaining to losses and gains. A central premise is that the
perception of financial statement users might be better understood and explained by incorporating
behavioral risk characteristics such as worry and control. Another purpose of this study is to
examine how users of financial statements perceive risk for 19 financial items for various levels
5.0 A Narrative Research Review of the Risk Perception Literature in Behavioral Finance
Long before social scientists started to investigate risk-taking behaviors, statisticians were
interested in studying gambling behaviors. Social scientists began to borrow the concepts
associated with gambling behavior and applied them in experiments concerning decisions under
risk and uncertainty. Unfortunately, many of these earlier studies within psychology utilized the
research methodologies developed by statisticians, which were primarily mathematical in nature
based on academic gambling studies. Gambling studies allowed for an exact mathematical
calculation to be utilized evaluating a subject's judgment of a precise monetary value for any
specific gamble by multiplying the chance of the probable gain or loss. However, these gambling
experiments have a major shortcoming limited to their objective nature of risk and do not
necessarily represent the risk-taking activities that individuals are faced with on a daily basis. In
particular, results from these gambling studies in psychology continually demonstrated subjects
did not appear to make their judgments based on statistics such as variance or standard deviation.
The decision-making process involving risk seems to be more complex and a multi-dimensional
endeavor with subjective (qualitative) aspects and objective (quantitative) components.
The initial research on risk-taking behavior has origins from experimental psychology in
particular, the research pertaining to experiments in gambling behavior during the 1960s and
early to mid-1970s. Pollatesk and Tversky (1970) describe the initial method to how scholars
utilized gambling techniques (i.e. games of chance) within the context of perceived risk:
The various approaches to study of risk share three basic assumptions. 1. Risk is
regarded as a property of options, (e.g. gambles, courses of action) that affects
choices among them. 2. Options can be meaningfully ordered with respect to
their riskiness. 3. The risk of option is related in some way to the dispersion, or
the variance, of its outcomes... Beyond these basic assumptions, however, no
general agreement concerning the nature of risk has been reached. Although
various assumptions about the perception of risk have been introduced, they have
not been derived from more basic principles, and they have typically been limited
to restrictive contexts. (p. 541)
The main theme of this early research on the “perception of risk taking” for games of chance
(lotteries) focused on how subjects make judgments among different gambling options especially
the combination of variance and expected value of the gambling task in a sample of dissertations
by Lichtenstein (1962), Slovic (1964b), Tversky (1965), and Payne (1973b) and academic studies
by Coombs and Pruitt (1960), Slovic (1962), Slovic (1967), Beach and Scoop (1968), Lathrop
(1970), Coombs and Huang (1970), Payne and Braunstein (1971), Lichtenstein and Slovic (1973),
and Payne (1975). Many of these early gambling experiments contributed to the later emerging
topics in the field such as the concepts of prospect theory, loss aversion, and the area of risk
perception studies pertaining to psychology, behavioral accounting, and behavioral finance.
1989 ----- (2) Evans, Holcomb, & Chittenden; LeBaron, Farrelly, & Gula
1990 ----- (3) Antonides; Roszkowski & Snelbecker; Snelbecker, Roszkowski, & Cutler
1995 ----- (3) Shapira; Levy & Lazarovich-Porat; Sullivan & Kida
21 studies from
the 1990s 1997 ----- (4) Levy; Olsen; Weber & Milliman; Schlomer
1998 ----- (4) Weber & Hsee; Baker; Marston & Craven; Sarasvathy, Simon, & Lave Stage 5
1999 ----- (3) Grable & Lytton; MacGregor, Slovic, Berry, & Evensky; Williams & Voon
47
50
45
40
The Number of 35 21
Research Studies for 30 15
25
Each Sampling 6
20
Category 15 1
10
5
0
Mailed Mailed Convenience Multi- Telephone
Survey Survey Sample method Survey
(Random (Nonrandom Research (Randon
Sample) Sample) Approach Sample)
Note: The sample groupings for the multi-method approach overlap (or are double counted) within the
mailed survey (random sample), mailed survey (nonrandom sample) and convenience sample since a few
studies are classified in more than one sampling category.
___
Individual investors
and investment
experts
9%
College students and
investment experts College students
5% (nonexperts)
Experts (two groups 33%
or more)
9%
Note: The expert group incorporated a wide range of academic and professionals including: finance professors, portfolio managers,
corporate managers, financial planners, financial analysts, stockbrokers, countertrade managers among others.
Another important aspect of these studies was the type of research group incorporated within each
endeavor (see Graph 2). The nonexpert groups (i.e. unsophisticated investors) of individual
investors and college students accounted for 47 percent of the research sample. The individual
investors were usually tested by means of a mailed questionnaire because they were clients of
investment companies or owners of a company’s stock. The university students are usually tested
within a classroom setting for a finance or an investments class so the researcher had access to easy
an ad-hoc sample. For instance, in the behavioral sciences a student sample is widely accepted if the
point of the research is to conduct exploratory or experimental research. In finance, student subjects
are a valid sample for testing a questionnaire within a pilot study framework. The other significant
group of study was knowledgeable professionals or experts that made up 39 percent of the total
research population. The viewpoint within academic finance is an expert group is a better
representative sample since these types of investors have real world knowledge and years of
investment experience. A review of the literature supports this trend of using only an expert sample
in works by Chan (1982), Johnson (1988), Ericsson and Smith (1991) and Mieg (2001) with the
assumption of obtaining a large random sample size within your research design. The last major
component utilized a comparative analysis between novice investors (i.e. individuals and college
students) vs. investments experts, which made up 14 percent of this sample.
Graph 3: Sample Sizes of Each Study for Subjects and Respondents for the
Behavioral Finance Risk Perception Studies
25
23
20
17
Less than
50 to 99
50 100 to
150 to
149 200 to
199 300 or
299
more
The Six Specific Sample Size Ranges Identified for this
Collection of Research Experiments and Studies
The next important aspect to consider regarding these studies was the mailed surveys with a
random sample namely the response rates and the total number of respondents from each study
(see Graph 4). This arrangement of studies provided a sample of 26 mailed surveys with a
random sample approach and corresponding response rates. The range of response rates for the
26 academic works was from 13% to 88%. Approximately fifty percent of surveys resulted in a
response rate in the range of 13 percent to 29 percent. Another 20 percent of surveys yielded a
response rate of 30% to 40%. The remaining 30 percent of surveys produced a response rate
within a range of 50% to 80%. All of these 26 mailed random samples involved either expert or
individual investors or a combination of these two groups. In terms of actual respondents from a
range of 100 to 400 completed surveys the range of response rates was 13% to 40% equivalent to
38 percent (10 of 26) of this sample of risk perception studies (see Graph 4 the light colored bar
for each study represents this sample of 10 studies). In terms of the nonrandom mailed
questionnaires that accounted for 15 studies (only 12 published response rates) in which 10 of the
12 had response rates in the range of 20% to 50%. (Note: The nonrandom mailed surveys were
not disclosed within a graphic format.) Either way scholars utilized many different survey
research methods for attempting to increase response rates for their studies whether a random or
nonrandom sample was part of the research design.
Response rates (%) and the number of respondents for each research work
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Note: Some of the research endeavors are presented more than once because they investigate multiple research groups (i.e.
Group 1 and Group 2) or utilize different versions of questionnaires (Questionnaire 1 and Questionnaire 2).
The author Blaylock (1985) examined the notion that the process of an individual’s risk
perception might be classified into 3 main components: 1) a cognitive aspect; 2) conventional risk
measures; and 3) the environmental setting. The study utilized a research sample of 56 MBA
candidates and student management majors assisted in an experimental design to evaluate these
three main factors of risk perception. The authors utilized the statistical method known as
analysis of variance with the research design to study behavior between students (i.e. within
subjects, between subjects). The subjects were asked to evaluate eight case studies based on
strategic/operations management based on an overall rating scale of 1 (being the least risky) and 7
(being the most risky). The author found that cognitive technique, decision situation, and
objective risk factors concurrently influenced a person’s risk perception.
McConnell, Gibson and Haslem (1985) for this study was based on the data collected (from the
McConnell dissertation in 1984) using a mailed questionnaire of 394 shareholders in a dual purpose
mutual fund with 84 items including investor information on: portfolio composition, return
preferences and investor attitudes on capital gains and dividends. The main discussion of this study
for this research work was from the section on knowledge and risk-taking behavior. This study
attempted to assess whether an investors’ knowledge was associated with their specific risk-return
preferences. The knowledge factor was determined by requesting from investors in a dual-purpose
mutual to provide their level of knowledge for 14 different types of financial securities. The 3 main
factors utilized for calculating risk preference was: 1) an investor’s preference for income vs.
capital gains; 2) their choice of dividends vs. capital gains; and lastly 3) their chosen level or extent
of risk aversion. For these 3 risk-return preference factors the results revealed, “that knowledge
was positively related to risk tolerance; that is, the more knowledge an investor had, the more risk
he or she was willing to take” (Roszkowski and Snelbecker, 1989, p.22).
Maital, Filer and Simon (1986) from the field of behavioral economics for their study provided the
findings of a game stimulation experiment of stock market activities focused on examining
individual and cumulative options in the face of random stock prices among 87 finance student
subjects. The authors utilized a stock market game simulation experiment in which subjects were
provided instructions prior to the beginning of the study including: a 36-week price history of the 7
hypo-ethical stocks (students were not informed that the price history was fictitious) and
instructions told subjects to maximize profits with a starting value of $10,000 in cash. All stocks
were assumed to follow a random walk and portfolio risk is a weighted average of each stock’s
Steil (1993) investigated the management of foreign exchange risk for 26 treasurers of
multinational corporations regarding the perceived risk by corporate treasurers for various products
(i.e. option hedging, forward hedging) in a real setting by actual experts. The author implemented a
multi-method research approach by first utilizing an extensive 1-hour telephone interview with each
participant to develop a questionnaire and later on in the study mailed each a follow-up survey. The
mailed survey contained one foreign exchange case related to risk and a collection of individual
questions on foreign exchange products and services to measure the experts’ perception of risk. The
author as part of the study utilized a qualitative research aspect on the survey that incorporated
open-ended questions for the respondent to provide extensive answers. The results of the study
revealed that the treasurers demonstrated loss aversion behavior (i.e. a desire to avoid large losses
or below-target returns) in their responses when confronted with the problems concerning foreign
exchange risk. The author posited that the respondents’ behavior could not be attributed to rational
economic models (Bayesian expected utility framework). The author concluded that certain
cognitive issues associated with risk and uncertainty influences the corporate treasury experts
including: loss aversion, regret theory, and framing.
Cassidy and Lamb (1994) investigated the association between the reported/perceived risk of
insurance agents and the actual risk of a pool of insurance companies (i.e. similar to building a
portfolio stocks by an investment manager). Two hypotheses that developed were: 1) Null
Hypothesis: The actual risk encountered by insurance agents is consistent with their perceived
risk and 2) Alternative Hypothesis: The actual risk encountered by insurance agents is not
consistent with their perceived risk. The authors mailed a survey to 1,000 insurance agents and
received a total of 112 usable questionnaires concerning the insurance companies they act for and
the percent of business placed with each firm. The survey provided asked the respondents to
categorize the risk associated with their insurance companies from very risk to no risk within a
total of five risk classifications. The results revealed that insurance agents in most cases, with
some differences, have a propensity to build a portfolio of insurance firms for different risk levels
that do not correspond with their own inclination for risk. In essence, “some agents may be
reporting a desire to take little risk but constructing a portfolio with higher than expected levels of
risk” (Cassidy and Lamb, 1994, p.46). Insurance representatives seem to create their portfolio of
firms devoid of the riskiness of the actual insurance firms.
Shapira (1995) investigated risk-taking behavior (he collected primary data from real decision
makers) from a total sample of 706 business managers across a wide range of public, private, and
military institutions in the Unites States and Israel. The author utilized a multi-method approach
of qualitative data from 50 interviews and a quantitative component from an in-depth
questionnaire for a total of 656 managers. The main purpose of the interviews and questionnaires
was to establish a definition of risk, evaluate the subject’s views towards risk, how these
managers deal with risk and each respondent provided a description of a recent situation that
involved either a personal or business decision. This study utilized an extensive qualitative
component on the survey since a majority of the questions were free response or open-ended
questions. The respondents of this study defined risk into four main characteristics: 1) The
managers displayed a tendency towards concern for downside risk; 2) The notion regarding risk
was the extent of the possible loss rather than its probability; 3) The respondents believed there
was a strong dissimilarity between risk taking behavior and gambling; and 4) They displayed
minimal desire to condense risk to a single risk dimension (i.e. beta for stock investment risk). In
terms of their viewpoint on the association between risk and return: 13% of the respondents
believe risk and return are related, 30% thought the two components were provisionally linked,
Baker (1998) examined how to recognize the performance assessment process by decision makers
(i.e. boards of trustees) influences the behavior of investment managers concerning their
perceptions of risk and time horizons (i.e. notion of short-termism). As part of this evaluation
process, the investment managers (64 UK fund managers) are reviewed on a regular basis against
performance benchmarks (i.e. usually a quarterly basis), however the scope of such appraisal and
the selection of standard benchmarks varies based on the category of funds under supervision. The
authors utilized a multi-method research design by conducting 64 interviews with investment fund
managers in combination with a survey instrument that measured their approach to portfolio
composition, types of securities invested with their portfolios, their perceptions of risk and return,
and the type of performance evaluation by their clients that’s administrated. In regards to their
perceptions of risk, the study focused on 4 main risk measures (commercial risk, asset-liability
matching, total variability of return, beta of portfolio) by the two investment characteristics of type
of fund and performance benchmark. The most significant risk measure for the two investment
criteria was the extent to which assets and liabilities are not matched, the 2nd moderately important
risk indicator was commercial risk, whereas the traditional investment risk measures (beta, variance
of returns) were a distant last. The results reveal that performance assessment affects fund experts'
Grable and Lytton (1999) examined whether specific issues involving a collection of
demographic, socioeconomic, and attitudinal variables that could be utilized in order to predict
the financial behavior of individuals with different levels of risk. A questionnaire was designed
to measure specific risk-behavior including: a risk tolerance index (classified two groups into
above average vs. below average risk tolerance investors), gender, age, marital status, occupation,
income, education, financial knowledge, and economic expectations. This survey was mailed to a
random sample of employees of a research university located in the Southeastern United States
that resulted in 1,075 usable surveys. The authors utilized the statistical method discriminant
analysis to assist in grouping investors into risk tolerance classifications by the respondent’s
demographic and socioeconomic characteristics. The findings revealed that an individual’s
educational level and financial knowledge were the best predictors of risk tolerance behavior and
a person’s income level and occupation were two other significant factors. The responses based
on gender, economic expectations, age, and marital status presented a low explanatory power
when compared with the others significant factors.
This study by Goszczynska and Guewa-Lesny (2000a) compared the perception of different
forms of money and financial assets in the bank employees and customers in Poland. Three Polish
banks were surveyed for the study (113 bank employees vs. 108 bank consumers) in which
participants were asked to evaluate the typicality (relates to the familiarity of assets) of 22 forms
of money (i.e. Polish money and coins) on a 7-point Likert scale. In terms of standard forms of
money (i.e. cash, notes) there was no significant difference between bank clerks and clients
(experts vs. novices), however, non-cash forms of money (i.e. stocks) revealed a divergence. The
bank clerks provided higher rating of typicality for seven forms of money such as bankcards,
shares, and insurance polices. This finding potentially has substantial implications since how
individuals perceive the typicality of money differently might extend to how investors perceived
the degree of risk associated with these different forms of money as investigated in the follow-up
study by the same scholars.
This next study incorporated the earlier work of Decision Research Scholars with the integration of
hazardous activities and the investment decision-making. The risk perception aspect focused on
investigating whether the ratings would be based on qualitative factors similar to those found in a study
by Slovic, Fischhoff, and Lichtenstein in 1980 involving technological and ecological risk. The
Goszczynska and Guewa-Lesny (2000b) examined 11 qualitative risk indicators (based on the earlier
work of Slovic and others) in which respondents were asked to judge their perceptions of risk on 7-
point Likert scales for 10 types of financial investments (i.e. stocks, bonds) among a sample of 3 banks
in Poland (113 experts vs. 108 novices). The main question explored was “Do experts and novices
differ significantly regarding their assessment of risk for various categories of financial assets?” The
responses between the two groups demonstrated a considerable divergence regarding the following risk
characteristics: the amount of profit, certainty of profit, judgmental independence, and familiarity for
specific categories of investment. The authors developed three risk dimensions (factors) including:
certainty of profit, the familiarity of risk, and the deferment of losses. These three risk dimensions
accounted for more than 60% of the total variance. Factor 1 known as “certainty of profit” was created
from the qualitative risk factors including: trust, amount of profit, income certainty, and independence
of judgment. The second factor labeled “familiarity of risk” was made up of controllability, knowledge,
and accessibility of information. The third factor “fear of immediate loss” dealt with loss postponement
and anxiety of loss (behavior attributed to loss aversion). The other major component of this endeavor
was to examine the connection between how typical various forms of money (relates to the familiarity
of assets) and their overall perceived riskiness based on qualitative constructs. The statistical analysis
with correlation and regression revealed that four significant risk indicators for describing the
“typicality of ratings opinions” of specific types of money were: trust, clarity of information,
knowledge and familiarity.
The 45 subjects were provided with a hypothetical case study in which they had assumed the role
of a marketing manager for a large manufacturing firm to decide to invest in three different new
product innovations. The cases provide specific financial information for each venture and
specific risk indicators including: the probability of loss (i.e. the product potential for failure) and
disclose the magnitude of loss (i.e. the size of the loss from the project or downside risk). The
findings revealed (supported both hypotheses mentioned above) that the subjects’ level of
perceived outcome control integrated with the specific decision area to establish subsequent
degrees of risk taking that are explicit to each factor of risk.
Dulebohn (2002) examined specific risk characteristics that workers employ when making
investment judgments for their employer-sponsored retirement plans. A field survey of college
and university employees (795 respondents) were given a questionnaire with a hypothetical
situation that requested them to decide on investment of eight allocation alternatives for a fixed
sum of $10,000 offered by defined contribution pension plans. The authors employed a collection
of 8 main hypotheses and utilized statistical methods such as intercorrelations and regression to
test them. The author investigated the importance of specific behavioral and demographic factors
regarding an employees' risk taking behavior within three risk constructs: 1) The ability for a
person to recover or cover a potential loss (income level, age, and investments in other retirement
plans); 2) the persons’ perceived personal control (internal locus of control, knowledge, self-
efficacy); and 3) behavioral tendencies (gender, overall risk propensity). The author used two
measures for evaluating investment risk: 1) an investment risk level in which respondents had to
rate each of the eight options with a risk scale of 1 to 8; and 2) a real loss tolerance that was
designed to assess the indicator for each person. The findings identified the main aspects of risky
taking behavior for the respondents of retirement plans including: 1) The socioeconomic
variables, income level and other retirement plan involvement had a positive association with a
persons’ investment risk behavior whereas age revealed an inverse relationship; and 2) The
variables dealing with behavioral factors: demonstrated a positive relationships self-efficacy and
knowledge of investment principles persons’ risk behavior; lastly overall risk propensity and risk
tolerance had a positive association.
A central aspect of this paper was to bring together the previous studies in the literature from the
three disciplines of behavioral accounting, behavioral finance, and psychology for the purpose of
conducting a risk perception study based on the academic foundation of the core themes, research
approaches, and findings from this collection of research endeavors. (The author is currently
working on this risk perception study for his dissertation.) Since the research studies from
behavioral accounting and behavioral finance consist of over 150 accounting, financial, and
investment surrogate risk factors the author has developed a structured approach known as the
Statistically Significant Method for Risk Perception Studies (Ricciardi 2004). Based on this
approach the author has selected the most important financial risk indicators and statistically
significant proxy variables from each risk perception study. With the utilization of an 18-step
process from the Statistically Significant Method for Risk Perception Studies has resulted in the
development of 6 financial risk indicators based on 15 proxy risk measurements from accounting,
finance, and investments (Ricciardi 2004). The 6 financial risk indicators are: a company’s
balance sheet liquidity, the financial condition (health) of the firm, the degree of volatility, the
concern for downside risk in percentage terms, the significance of earnings, and the expected
investment performance for the stock.
Whereas, the selection of the 6 behavioral risk indicators and 5 decision making attributes are
based on the past findings, main issues, and the emerging topics that could affect a person’s
perception of risk. An investment professional’s perception of risk for a stock might be
influenced by a combination of several different financial and behavioral risk characteristics. A
major source of the selection of the 6 behavioral risk characteristics and the 5 decision-making
attributes was based on the narrative review of the 17 works from the risk perception studies in
psychology associated with hazardous activities. (The individual narrative reviews of these 17
studies are not provided within this paper.) The selection of the behavioral risk characteristics and
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