Caterina Lucarelli

Risk tolerance in financial decision making

Introduction C.Lucarelli The Role of Risk in the Investment Decision Process: Traditional vs Behavioural Finance C.Mazzoli & N.Marinelli Household Behaviour and Debt Demand D.Vandone The Traditional Approach to Risk Tolerance C.Mazzoli & N.Marinelli Risk of Over-indebtedness and Behavioural Factors L.Anderloni & D.Vandone Decision Making: Psychological Perspective C.Ottaviani, V.Nucifora, R.Borlimi & G.Brighetti The Layout of the Empirical Analysis C.Lucarelli, C.Ottaviani & D.Vandone The Indicators of Risk C.Lucarelli & G.Palomba Results on the Investment Side C.Lucarelli The Determinants of Household Debt Holding: An Empirical Analysis D.Vandone & C.Ottaviani The Implications for Market Participants and Regulators G.Brighetti, C.Lucarelli & D.Vandone

Investors' Behaviour in the Chinese Stock Exchanges: Empirical Evidence in a Systemic Approach

This paper investigates the Chinese mainland Stock Exchanges and their following interconnecting features: savers’ attitude towards stock investments, investors’ trading behaviour and stock returns explanations. We evaluate the effectiveness of the recent efforts made by the Chinese authorities to improve the level of legal protections for shareholders and the opening-up of the Chinese Stock Markets to foreign investors. The whole analysis is carried out through a system of simultaneous equations. The main results are that Chinese shareholders and stock markets are mostly driven by emotional behaviour. Stock market returns are barely influenced by the overall Chinese economic booming, but reveal the presence of speculative influences. Investors’ behaviour, as well as general trading activities, hardly seems to be affected by the legal framework introduced by the national Authorities.

Gender differences in attitudes towards risk and ambiguity: when psycho–physiological measurements contradict sex–based stereotypes

This paper investigates gender differences in behaviour under uncertainty, as this personal condition influences entrepreneurship. We explore risk taking attitude and ambiguity aversion used in economic decisions on a sample of 645 individuals. We collect objective measurements of risk/ambiguity aversion from a psycho-physiological task, and we gather self-assessments of individual risk tolerance from a verbatim questionnaire. Our findings show no statistical gender difference when risk/ambiguity attitudes originate from the psycho-physiological task. Conversely, self-evaluated risk tolerance indicates that women define themselves as risk averse, whereas men define themselves as risk lovers. These differences are statistically significant and persist in a multivariate framework, excluding an indirect effect due to education, self-esteem, wealth, impulsivity, and other controls. This supports the concept that self-assessed risk attitude originates from an overall (wrong) social construct. Women evaluate themselves coherently with this sex-based stereotype and end up reinforcing the social idea of their inferior attitude to assume risks.

Errors in Individual Risk Tolerance

This paper focuses on risk tolerance which clearly influences financial decision making. We explore the emotional side of a risk taking behaviour, comparing alternative measures of financial risk tolerance resulting from the consilience of various disciplines. We wonder whether we financially act as we are or as we are supposed to be. Thus we measure first, an unbiased risk tolerance (UR), which is obtained from the psycho physiological reactions of individuals taking risk in laboratory experimental settings; second, a biased risk tolerance (BR) obtained through a psychometrically validated questionnaire. Finally we compare these indicators with risks assumed in the real-life. Our findings confirm that people tend to behave coherently to their self-representation and almost in stark contrast to what they feel. Nevertheless, experiments conducted on more than 440 individuals, with a large presence of trader and asset managers allow us to prove evidence of an ‘unconscious sleeping factor’ which is remarkable when the unbiased risk is much higher than the risk assumed in real life but, at the same time, higher than the self-evaluation. Our findings induce us to propose a model of mental functioning that places rationality and emotion side by side to a third factor: the counterfactual thinking and the wandering mind. The sleeping factor is totally absent in traders and asset managers.

Do emotions affect insurance demand

Purpose - – The purpose of this paper is to explore how psychological variables are related to real-life insurance consumption. Specifically, the authors focus on whether emotions and psychological traits can improve the predictability of insurance demand, taking traditional socioeconomic variables under control. Design/methodology/approach - – The approach used was in-person survey, based on a traditional questionnaire, the Barratt Impulsiveness Scale and a psycho-physiological task (Iowa Gambling Task (IGT)). Findings - – A selective role of emotions and psychological traits has been proven to exist when comparing different insurance policies. Life and casualty insurance are affected by emotional arousal to losses; indemnity insurance by fear of the unknown, whereas health insurance by impulsivity. Research limitations/implications - – The findings indicate that individual insurance consumption may be amplified by not cognitive components. Future research should concentrate on testing the effect of further psychological traits related to pure risk coverage. Practical implications - – The results may be of interest for insurers in order to know what drives insurance demand with respect to different kinds of pure risks. Social implications - – For policymakers, it is important to understand how psychological factors affect consumer behavior in order to incorporate such perspective into modern insurance policy measures. An analysis of such factors may also increase the self-consciousness of insurance consumers and enrich consumer self-protection. Originality/value - – The authors propose an interdisciplinary approach to analyze insurance demand and test different kinds of insurance coverage, suggesting not homogenous hedging behaviors in relation to specific ambiguous events.

Pre-Trade Transparency and Trade Size

We analyse how Pre-Trade Transparency (PTT) affects the behaviour of different stock traders. To do so, we exploit a natural experiment, that is the PTT change in the equity segment of Italian Stock Exchange (ISE) which occurred in July 2007, with the aim of reducing information asymmetries between individuals and intermediaries/institutional investors. We specify a dynamic empirical model for trade size and estimate it on a large panel of tick-by-tick data. Results suggest that increased transparency affects the dynamic trade pattern emerging from interacting strategic decisions of different traders. In addition, the contribution of the order flow disclosure both in reducing the adverse selection component of the bid--ask spread, and in weakening the sensitiveness to risk of the trade size also emerges. Overall, PTT enhancement should reduce the informative disequilibrium among market participants and improve the quality of the market.

A Cross-Country Model for the Influence of the Pre-Trade Transparency on Market Liquidity and Price Volatility

In this article, we examine how the pre-trade transparency (PTT), a specific market microstructure feature, affects the liquidity and the price volatility of a stock exchange. In particular, we estimate a system of simultaneous equations for a set of liquidity and volatility indicators as a function of the PTT, given a series of control variables. Our main finding is that transparency increases liquidity and reduces volatility, and this is coherent with part of the existing literature. Moreover, the analysis provides empirical evidence of a series of liquidity—volatility interconnections.

How financial information disclosure affects risk perception. Evidence from Italian investors’ behaviour

ABSTRACT This paper investigates how different representations of financial information may be appraised in terms of complexity and usefulness, and how financial disclosure influences individuals’ risk perception. By using a consumer testing analytical approach, we run a survey on a sample of Italian investors: 254 bank customers were submitted 4 different templates, each combining a different typology of data (historical and prospective) and framing (words, numbers and charts) to indicate the same level of risk and return of four real-life financial instruments. Representation formats partially overlap with those mandated by regulators and used within the financial industry. Results show that the perceived riskiness of financial products is affected by the way information is disclosed. Perceived complexity of the financial information disclosure intensifies perception of riskiness of the product solicited. Gender, age, personal traits, behavioural biases and financial knowledge, do also play a role. Overall, given investors’ heterogeneity and behavioural biases, neither simplifying disclosure nor a ‘one-size-fits-all’ approach may be sufficient to ensure correct risk perception and to prevent unbiased investment choices.

Individual behaviour and long-range planning attitude

Declining welfare systems increase the importance of self-determination in pension decisions. Thus, the stability of long-life consumption markedly relies on individual long-range planning attitude. Our paper investigates how behavioural traits affect this attitude and influence the probability of holding voluntary integrative pension schemes (VIPS). We find that psychophysiological heterogeneity plays a role in predicting demand for VIPS, together with saving/indebtedness style and conventional sociodemographic characteristics. Specifically, individuals who have a high degree of non-planning impulsiveness, and who are inclined to intense psychophysiological arousals, are less likely to demand VIPS. Our results imply that behavioural individualities might prompt individuals to postpone, or even neglect, decisions necessary to maintain stable lifestyles in the long range.

Long-Range Financial Decision-Making: The Role of Episodic Prospection

Individuals often show time-inconsistent preferences when making intertemporal choices for monetary rewards. Time-inconsistent preferences generally emerge when observing the devaluation of outcomes over time (temporal discounting) that do not follow an exponential discounting function, but rather hyperbolic discounting. In this paper, we argue that temporal discounting is sensitive to the type of prospection involved. Given that episodic prospection (when individuals can vividly envisage possible future events) increases the subjective importance of a future reward, we investigate if and how it can effectively attenuate human biases of temporal discounting. Our findings suggest that episodic prospection might attenuate intertemporal choice inefficiencies, when in the form of hyperbolic discounting. This was found to be particularly true if the solicited scenario referred to a primary need (a first priority).