Now that we know loss aversion is a key factor that drives risk tolerance, it is important for investors to take steps to reduce their loss averse tendencies, Guillemett noted."
Washington, July 31 - The more averse, or fearful, of losing money an investor is, the lower his or her willingness seems to be for taking risks in the stock market, says a study.
Traditionally, it was believed that spending habits were the main driver of risk tolerance (willingness to take risks), meaning the more variation an investor was willing to accept in their spending, the higher their risk tolerance for investments, said Michael Guillemett, assistant professor at University of Missouri.
Our study found that no such relation exists between risk tolerance and spending habits, Guillemett added.
Rather, loss aversion is a much more accurate indicator of risk tolerance, Guillemett explained.
Consumer sentiment also appears to help explain investors' risk tolerance, though not nearly as much as loss aversion, according to the study.
Researchers analysed data from a risk tolerance survey taken from 2003-2010 for the study.
Guillemett focused on three potential drivers of risk tolerance: loss aversion, changes in investor spending habits and changes in consumer sentiment levels.
Now that we know loss aversion is a key factor that drives risk tolerance, it is important for investors to take steps to reduce their loss averse tendencies, Guillemett noted.
This study is forthcoming in the journal Financial Services Review.