Risk Tolerance of Investors: Developing a Psychometric Tool

Abstract

Assessing client risk tolerance is one of the most important activities for financial planners. Although risk tolerance evaluation is a key input in the formulation of individualized portfolios, academics and practitioners have not yet paid much attention to this variable. In the absence of a standard method, various techniques have been used by investment advisors to measure the risk tolerance. Developing a reliable psychometric tool would immensely help academics and financial planners in further studying the complex investor behavior. This study is an attempt to develop a reliable instrument for assessing the financial risk tolerance of investors. This research is motivated by the documented evidence from the literature that assessment of financial risk tolerance is critical to optimal allocation of scarce capital resources. The study is interdisciplinary in nature involving the basic constructs of psychology.