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Effects of market returns and market volatility on investor risk tolerance

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Abstract

The 2008 credit market debacle and subsequent “Great Recession” accompanied by the stock market crash of 2008 has caused many investors and their advisors to reevaluate their risk tolerance and investment asset allocation choices. Additionally, marketers for many financial institutions and investment advisors are rethinking the strategies and tactics they use for both individual and corporate clients about the level of risk that is appropriate to meet their investment objectives. This research shows that an investor’s risk tolerance is not as stable as it has been portrayed previously in the literature and can be affected by both the direction of movement and the volatility in the market. In addition, this research provides some suggestions on how to frame investment decisions for individual investors to better assess their actual risk tolerance in the face of a volatile market.

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Author information

Authors and Affiliations

  1. Lacy School of Business, Butler University, 4600 Sunset Avenue, Indianapolis, IN, 46208, USA

    Courtney Droms Hatch

  2. Raymond A. Mason School of Business, William & Mary, Miller Hall 2041D, Williamsburg, VA, 23187, USA

    Kurt Carlson

  3. McDonough School of Business, Georgetown University, 3700 O Street NW, Washington, DC, 20057, USA

    William G. Droms

Authors
  1. Courtney Droms Hatch
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  2. Kurt Carlson
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  3. William G. Droms
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Corresponding author

Correspondence to Courtney Droms Hatch.

Appendices

Appendix 1: Graphical depictions of market conditions for Studies 1 and 2

Panel A: Market up & low volatility

figure a

Panel B: Market up & high volatility

figure b

Panel C: Market down & low volatility

figure c

Panel D: Market down & high volatility

figure d

Appendix 2: Risk tolerance measure

Please read each statement below and indicate the extent to which you agree with it. (1 = strongly disagree; 7 = strongly agree).

  1. 1.

    Earning a long-term rate of return that will outpace inflation is one of my most important investment goals.

  2. 2.

    Protecting the value of my existing capital is not as important to me as earning a high long-term rate of return.

  3. 3.

    I would be comfortable “riding out” a major market downturn in the expectation that my long-run results will be higher than I would earn in less volatile investments.

  4. 4.

    I am psychologically prepared to tolerate wide swings in the value of my investment portfolio.

  5. 5.

    I am financially prepared to tolerate wide swings in the value of my investment portfolio.

  6. 6.

    I am willing to invest in less liquid assets in order to seek higher returns.

  7. 7.

    I am willing to tolerate sharp downswings in the return on my investments (e.g., stock market investments) in order to seek a potentially higher return than would be available from more secure investments (e.g., US Treasury Bills or bank CDs).

  8. 8.

    I am willing to risk a short-term loss in return for a potentially higher long-run rate of return.

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Hatch, C.D., Carlson, K. & Droms, W.G. Effects of market returns and market volatility on investor risk tolerance. J Financ Serv Mark 23, 77–90 (2018). https://doi.org/10.1057/s41264-018-0049-6

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  • DOI: https://doi.org/10.1057/s41264-018-0049-6

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