Predicting Financial Risk Taking Behavior

Book excerpt: The purpose of this study was to compare and contrast the predictive validity of risk tolerance questionnaires. The tested questionnaires represented measures derived from economic and psychometric theory. It was determined that questionnaires based on economic theory had similar predictive power, implying that both measures provided some degree of reliability across measures. Only the psychometric theory-based risk tolerance measure was found to be correlated to other indicators of risk tolerance. Specifically, scores on the psychometric scale were correlated with knowledge of casino games, the likelihood of gambling, financial decision making experience, and investing knowledge, as well as participant holdings of cash and equities. A key finding from this study is that the psychometric questionnaire was the only measure to predict who was more likely to participate in a risk taking game where the outcomes of the game were unknown and potentially negative. Results from this exploratory study suggest that a questionnaire developed using psychometric theory appears to offer superior predictive ability of financial risk taking, at least when compared across the measurement techniques examined in this study.