Estimating Risk Tolerance: Legal Obligation and Competitive Advantage

Transcription

1 BeFi Conference Topic 5 Estimating Risk Tolerance: Legal Obligation and Competitive Advantage by Dr. Martin Weber University of Mannheim BeFi Forum 2007

2 Behavioral Finance Forum 2007 Conference Estimating risk tolerance - Legal obligation and competitive advantage University of Mannheim

3 Overview 1. Profile a. Vitae b. Previous Research 2. Motivation a. Behavioral principles b. Legal obligation c. Improving service 3. Research Ideas a. Efficiency of risk tolerance questionnaires b. Changes in risk attitudes and their impact on portfolio choice 4. Conclusion 2

4 Overview 1. Profile a. Vitae b. Previous Research 2. Motivation a. Behavioral principles b. Legal obligation c. Improving service 3. Research Ideas a. Efficiency of risk tolerance questionnaires b. Changes in risk attitudes and their impact on portfolio choice 4. Conclusion 3

5 1. Profile - Vitae Education: M.Sc., M.B.A., Ph.D., venia legendi (Aachen University) Positions: Professor of Business (Cologne University) Professor of Business (Kiel University) present Professor of Business (University of Mannheim) - Visiting: Fuqua School of Business, Stanford University, University of Vienna, Anderson School of Management UCLA, Wharton School, Helsinki School of Economics Teaching: - Banking, Decision Analysis and Behavioral Finance Others: - Dean School of Business University of Mannheim (04-06) - Co-Founder (1997), Director ( ), Deputy Director (2003-present) of national research center on decision making (SFB 504) Graduate students Executives - Projects with various industry members - Expert witness for courts - Review board of German National Science Foud. - Member of two German Academy of Sciences 4

6 Popular book Over x thousand sold Extensive press coverage 5

7 1. Profile - Previous Research Investment Decisions and Time Horizon: Risk Perception and Risk Behavior in Repeated Gambles (joint work with Alexander Klos and Elke Weber, MS 2005) - Task: Estimate several risk measures for various short/medium/long time horizon lotteries 1/ / Results: Risk estimation prone to errors: In particular for long time horizons Risk perception is more influenced by intuitive risk measures (Prob. of Loss, Mean Excess Loss, ) than by standard risk measures (Std.Dev.) Risk taking behavior best predicted by subjective risk perception Overconfidence and Trading Volume (joint work with Markus Glaser) - Theory: More overconfident more trading volume (e.g. Odean, 1998, JF) - Data: Real trading behavior (Discount broker) + Questionnaire study with clients - Results: More above average more trading volume More miscalibrated more trading volume 6

8 1. Profile - Previous Research An Individual Level Analysis of the Disposition Effect: Empirical and Experimental Evidence (joint work with Frank Welfens) - Previous findings: Disposition Effect (sell winners hold losers) exists on aggregate (Odean, 1998, JF; Weber and Camerer, 1998, JEBO) - Research question: How does the DE exist on an individual level? - Data: Real transaction data (Discount broker)+ Experimental Data - Results: DE on individual level varies considerably DE in the gain domain not related to DE in the loss domain DE is stable within a task, across different tasks and across time Advisor client relationship (joint project with Sina Borgsen) - Task: Assess risk preferences of others (clients) - Results: Average risk preferences of others are too similar to own ones Too narrow confidence intervals à Don t take into account that risk preferences might be different Þ Service too standardized 7

9 Overview 1. Profile a. Vitae b. Previous Research 2. Motivation a. Behavioral principles b. Legal obligation c. Improving service 3. Research Ideas a. Efficiency of risk tolerance questionnaires b. Changes in risk attitudes and their impact on portfolio choice 4. Conclusion 8

10 2. Motivation - Behavioral principles Risk taking is driven by two factors Preferences Beliefs Risk Attitude Loss Aversion Overoptimism Overconfidence 9

11 2. Motivation - Behavioral principles Risk taking is driven by two factors Preferences Beliefs Risk Attitude Loss Aversion Overoptimism Overconfidence Theory: Less risk averse More risk taking Empirical Findings: Relation risk attitude and risk taking not clear-cut (Klos and Weber, 2003) Theory: More overconfident / overoptimistic More risk taking (e.g. Daniel et al. 2001, JF) Empirical Findings: More overconfident / overoptimistic Þ More risk taking (Nosic and Weber, 2007) 10

12 2. Motivation - Legal obligation MIFID EU Markets in Financial Instruments Directive (MiFID) - Directive 2004/39/EC of the European Parliament and of the Council - Directive 2006/31/EC of the European Parliament and of the Council - Commission Directive 2006/73/EC (Implementing directive) Investment firms (should) obtain from clients information to understand the essential fact about the client 19 (4) & 35 (1) Information shall include his preferences regarding risk taking, his risk profile and 19 (4) & 35 (4) Case study: Fokker (BGH XI ZR 159/99 WM 2000, 1441) Risk averse investor got advice to invest in DMdenoted-industry-bond Bank advised investment: kind of Dutch government bond Customer was awarded damages 11

13 2. Motivation - Improving service Risk questionnaires are not particularly efficacious (anonymous practitioner) - Too short - Badly worded - Combine questions to a number of dimensions (investment goals vs. risk) in several domains (financial vs. leisure) - Do not incorporate behavioral findings Improving questionnaires is necessary Advantage of improved service + Lower risk of legal charges + Advisors understand customers needs Customized solutions Offer customized products 12

14 Overview 1. Profile a. Vitae b. Previous Research 2. Motivation a. Behavioral principles b. Legal obligation c. Improving service 3. Research Ideas a. Efficiency of risk tolerance questionnaires b. Changes in risk attitudes and their impact on portfolio choice 4. Conclusion 13

15 3. Research Ideas - Efficiency of risk tolerance questionnaires Question? Do risk tolerance scores match actual portfolio choices? or Questionnaires only used to appease regulator? Method Correlate elicited risk scores with actual portfolio choices Variables influencing answer to above question - Various elicitation methods - Date when the score was collected - Duration of customer relationship - Demographics 14

16 3. Research Ideas - Efficiency of risk tolerance questionnaires Data: Portfolio Data End of the year portfolio holdings Risk Data Elicited risk tolerance score Date and elicitation method Demographics Duration of customer relationship Earnings Job Marital status Children Age Sex Education 15

17 3. Research Ideas - Efficiency of risk tolerance questionnaires Why happy with which result? Risk tolerance scores match portfolio choice (high correlation) - Evidence that elicitation method is valid and correct In case of lawsuit Appease regulators - Marketing tool - Competitive advantage Risk tolerance scores do not match portfolio choice (low correlation) - Evidence that changes need to be made - Incentive to develop improved elicitation methods - If different elicitation methods à use the best - Find out for whom method worked particularly bad 16

18 Overview 1. Profile a. Vitae b. Previous Research 2. Motivation a. Behavioral principles b. Legal obligation c. Improving service 3. Research Ideas a. Efficiency of risk tolerance questionnaires b. Changes in risk attitudes and their impact on portfolio choice 4. Conclusion 17

19 3. Research Ideas - Changes in risk attitudes and their impact on portfolio choice Is it sufficient to elicit risk tolerance once and never again? Financial institutions required to elicit risk attitude regularly No! Risk attitude and risk taking not stable - Vary over time (E. Weber and Milliman 1997, MS) - Influenced by prior outcomes (Thaler and Johnson 1990, MS) - Affected by background risk (Klos and Weber 2006, GER) - Influenced by marital status, children,... 18

20 3. Research Ideas - Changes in risk attitudes and their impact on portfolio choice Research Questions: - How often should you elicit risk attitude? Identify events that lead to changes in risk attitudes and risk taking behavior - Do other variables predict changes in risk taking? Loss Aversion Overoptimism Overconfidence Research Method: Portfolio choices Portfolio choices Measure risk & other variables Measure risk & other variables Measure risk & other variables 19

21 3. Research Ideas - Changes in risk attitudes and their impact on portfolio choice Data: Same data as in first research idea Questionnaire study data Risk attitude and risk perception elicited in several ways Loss aversion elicited in several ways Belief measures: Optimism and confidence + Results: Know how often to elicit risk tolerance Know what triggers changes in risk taking behavior Test which other variables could help identifying risk taking behavior 20

22 Overview 1. Profile a. Vitae b. Previous Research 2. Motivation a. Behavioral principles b. Legal obligation c. Improving service 3. Research Ideas a. Efficiency of risk tolerance questionnaires b. Changes in risk attitudes and their impact on portfolio choice 4. Conclusion 21

23 4. Conclusion What is in for you? - Evaluation of your current risk tolerance scores Do elicited scores match actual behavior? - Find out how often you should elicit the risk tolerance of your customers Classify events that lead to changes in risk taking behavior - Identify other behavioral variables that reliably predict changes in risk taking behavior of your customers Improve your risk tolerance estimation process What is in for us? - Analyzing interesting behavioral research questions - Using first hand empirical data - Conduct a questionnaire study with actual consumers 22

24 PRESENTED BY Shlomo Benartzi Co-Founder, BeFi Associate Professor Co-chair of the Behavioral Decision Making Group The Anderson School at UCLA Warren Cormier Co-Founder, BeFi President, Boston Research Group BeFi Forum 2007