Factors effecting risk tolerance in

Households

Fawwad Zahir- 213734

Ali Hyder Zaidi - 217141
Introduction

• A person’s attitude towards accepting risk.

• Four dimensions: Financial, Physical, Social and ethical
• Financial risk tolerance, defined as the maximum amount of
uncertainty that someone is willing to accept when making a
financial decision (Grable, 2000).
• may determine the composition of assets in a portfolio

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Important Determinants of risk tolerance

• Wealth and Income

• Gender
• Financial literacy

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Wealth and Income
• Relative risk (portion of wealth)
• absolute risk (amount of money)
• Expected utility theory establishes that, in an absolute
sense, risk aversion decreases with wealth (Huang and
Litzenberger, 1988)
• In relative sense risk aversion increases with wealth.
(Graves, 1979)
• Lower level income means fewer resources available for
saving and investment.
• The level of non-investment income has a positive effect
on risk tolerance. ((Sung, Hanna, 1997)
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GENDER
• Stereotypically females are less risk tolerant, more risk
averse
• Females have a RTS of 6.20 less than males on scale of 1-
100 (Hallahan et al, 2003)
• The participation of women in financial market is far less
than that of men (Rooij et al, 2011)
• Difference can partly be attributed to less financial
literacy among women and partly to their less risk
tolerance ( Almenberg, Dreber, 2015)

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• Women invest less in risky assets and their
portfolios are less risky than men’s (Charness,
Gneezy, 2011)

• Households headed by male are more risk tolerant

than those headed by female (Sung, Hanna, 1997)

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Reasons for Different Investment Behavior

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Reasons for Different Investment Behavior
Bajtelsmit and Bernasek (1997) give following reasons
1. Difference in Wealth
• According to (SOEP) study, significant raw gender wealth gap in Germany of
approximately 30,000€. 50,000€ for married partners. (Sierminska et al, 2010)
• According to SCF (2013) average wealth of a single female is only 32% of a single
male (Mariko Chang)
2. Difference in Income
• Women on average earn less than men in most of the countries (UN ILO)
3. Difference in Employment
• Women are under represented in senior and mid level management positions and
over represented in low paying jobs. (Reskin and Hartmann, 1986; Reskin, 1988)
• Frequent job switching

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 Financial literacy
• According to Remund (2010), “Financial literacy is a measure of the
degree to which one understands key financial concepts and
possesses the ability and confidence to manage personal finances
through appropriate short-term decision-making and sound,
long-range financial planning, while mindful of life events and
changing economic conditions”

• Various authors have studies the relationship if individuals with

higher financial literacy have more risk taking behavior than people
with less financial literacy.

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• In addition, Grable (2000, p. 628) argues that a
combination of the factors can explain variability in
financial risk tolerance between groups of individuals
with different demographical backgrounds, if one were
to take into account that there are possible interactions
among and between the variables.

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RESEASRCH QUESTIONS
• Do individuals differ in financial risk tolerance due to their
level of financial literacy? (Omark, 2015)

• How actual financial literacy (i.e. financial literacy

derived from formal education) and financial literacy
derived from experience, such as stock market
experience affects financial risk tolerance (Omark, 2015)

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• Higher financial literacy are both related to increased
financial risk tolerance. (Hallahan et al, 2004)
• The authors also evaluated self perception of financial
literacy in contrast to actual objective financial
understanding by using financial literacy tests.
• The authors find out that average respondent had
realistic view of their financial literacy. Hence individuals
with low financial literacy shows awareness of its lacking
of financial knowledge , and avoid financial risks. Findings
could not detect any overconfidence (Omark, 2015)

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• The author analyzed the relationship of financial literacy
and financial risk tolerance with respect to higher level of
education, stock market experience and overconfidence
bias. (Omark, 2015)

• Previous studies in this relationship study confirmed that

higher level of education, financial understanding and
experience on the stock market resulted in higher
financial risk taking (Hallahan et al, 2004)

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• Financial literacy is crucial in long run in order to reinforce
household wealth and financial development.

• Large differences in financial literacy can create financial

gap in society , resulting in implications for financial
situation of the society. (Omark, 2015)

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IMPLICATIONS \ CONCLUSIONS
• women have overall less wealth and income and they invest in less
risky assets, making their overall return lower. As women mostly are
employed in low paid jobs, they are less likely to have employer
sponsored pension plans. This can result in financial distress in older
age. So they have to depend on their personal savings in old age.

• Thus policy makers should develop such schemes which allow

women to take more risk, such as investment funds in an expert
way.
• Further as discussed above, financial literacy schemes designed
specially for women. This can bring strong positive results for
households.

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• Financial literacy is an Important determinant in overall
confidence in participating in financial markets and
products.

• Research in this regard suggest measures to increase in

overall literacy in public. These include learning such as
• Employer based
• School based
• Community based

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• Improving financial literacy should be a first order
concern for finance authorities, as gains could accrue not
only to effected individuals but to their family members
and society at large. (Gale, Levine, 2010)

• Constant incentives to increase financial literacy and

stimulate interest in financial development is crucial
regardless of risk preferences. (Omark, 2015)

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THANK YOU!!

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References
• Remund, D.L. (2010). Financial Literacy Explicated: The Case for a Clearer Definition
in an Increasingly Complex Economy. The Journal of Consumer Affairs, Vol. 44, No.
2,
• Gale, W, Levine Ruth, (2010) “ Financial literacy: what works ? How could it be
made more effective
• Gustafsson, Carina, and Lisa Omark. (2015) Financial Literacy's Effect on Financial
Risk Tolerance: A Quantitative Study on Whether Financial Literacy Has an
Increasing or Decreasing Impact on Financial Risk Tolerance. Umeå School of
Business and Economics
• Bajtelsmit, V, L. & Bernasek, A. (1997).Why Do Women Invest Differently Than
Men? Financial Counselling and Planning, VII, 1-10.
• Hallahan, T & Faff, R & McKenzie, M(2003). An empirical investigation of personal
financial risk tolerance. Financial Services Review L3, 57-78

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REFERENCES
• Charness, G & Gneezy, U (2011).Strong Evidence for Gender Differences in Risk
Taking. Journal of Economic Behavior & Organization 83, 50– 58
• Grable, J, E. (2000). Financial risk taking and additional factors that effect risk taking
in everyday money matters. Journal of Business and Psychology Vol. 14, No. 4
• Almenberg, J & Dreber, A.(2015).Gender, stock market participation and financial
literacy. Economics Letters 137 (2015) 140–142
• Sung, J & Hanna, S. (1997).Factors Related To Risk Tolerance. SSRN Electronic
Journal
• Sierminska, E, M. & Frick, J, R. (2010). Examining the Gender Gap. Oxford Economic
Papers 62, 669-690 669. Oxford University Press
• Graves, P, E. (1997) Relative Risk Aversion: Increasing or decreasing ?J OURNAL OF
FINANCIAL AND QUANTITATIVE ANALYSIS Vol. XIV, No. 2, June 1979, pp. 205 - 214

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