Risky decision making in investment : an experimental study

Abstract

This research investigates why some individuals make better decisions in risky investments than others and what individual/socio-demographic characteristics influence in making these decisions. Three research questions with nineteen hypotheses were developed for the investigation. The first research question was (RQ1) Which demographic factors (gender, age, ethnicity, education, and investment experience), decision making styles and personality traits affect financial risk tolerance, financial literacy and risky decision making? Second research questionw as (RQ2) Is there any significant relationship between financial risk tolerance, financial literacy and risky decision making? And the third and last research question was (RQ3) Which combination of demographic factors (gender, age, ethnicity, education, and investment experience), decision making styles and personality traits predict financial risk tolerance score and financial literacy score? The investigation included two risk decisions making experimental tasks i.e. Iowa gambling task (IGT) and the balloon analogue risk task (BART) and an online questionnaire in which 244 UK respondents participated. The participants included professional (71%) and nonprofessional (29%) investors. Mixed factor ANOVA, one way ANOVA, Pearson correlation and multiple regression were used to analyse the data. (RQ1) There were no significant differences in the gambling task performance based on financial knowledge, investment experience, personality traits and demographics. There were significant differences in basic and advances financial literacy based on gender, age and investment experience. (RQ2) The results of the mixed factor ANOVA showed that there was no significant main effect of financial risk tolerance on the Iowa gambling task performance but a significant interaction was found to be present. Thus, financial risk tolerance high or low does not affect the risky decision-making task performance. The results of mixed factor ANOVA results show that same level of perceived financial knowledge and actual financial literacy was significantly related to better performance on the Iowa gambling task. Therefore, overconfidence or under confidence about one's level of financial understanding affects performance on risky decision-making tasks. (RQ3) 28% variability in the financial risk tolerance score is explained by the predictors gender, financial literacy score, spontaneous decision style, extraversion and investment experience. The regression model showed that gender, financial risk tolerance score, rational decision making, intuitive decision making and investment experience cause 38% variability in financial literacy score. \nThe participants did learn to make better selections in the gambling task but still majority 56% of them displayed impaired performance. Based on the findings of the research it is recommended that the importance of financial literacy and investment experience should be considered when the financial consultants prepare the investors profile. It is also recommended that the assumptions for measuring healthy performance on the Iowa gambling task should be evaluated carefully when applied to healthy participants in such a way that the individual differences are also incorporated.

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