What Consob (Italian market regulator) says about the use of behavioral finance in risk-profiling?
Extract from Assessing investors’ risk tolerance through a questionnaire
N. Linciano, P. Soccorso, Consob, 2011
1.3 The contribution from neuroscienceNeuroeconomics studies economic behaviour by analysing how the human mind works and, in particular, which neuronal areas are activated when certain choices, such as those under uncertainty, are made.Neuroeconomic experiments confirm the systematic anomalies observed by behavioural finance scholars by showing that certain situations always stimulate the same neural areas and hence the same responses. For example, just looking forward to a monetary gain can activate cerebral areas which alter the risk-return perception in favour of the latter. Moreover, while the expected gain is perceived immediately,the related probability is estimated afterwards so any changes to probability lead to delayed responses with respect to responses triggered by changes in the gain. Loss aversion also seems to be driven by the neuronal areas which process negative feelings, such as anxiety and fear, and make current choices dependent onpast experience. The experimental data, for example, has shown that most healthy people avoid risk after suffering a series of financial losses. However, individuals with damaged amygdalae had a lack of loss aversion even though they had normal levelsof general risk aversion (Motterlini, 2010).Neuroeconomics explored also intertemporal choices. Dynamic inconsistency would seem to be triggered by the interplay of several areas of the brain that identify conflicting priorities, leading to behaviour which, as already noted, can be represented through hyperbolic discounting2 Assessing risk tolerance and intertemporal risk preferencesThis paragraph contains a review of the tools which may be used to elicit risk tolerance. (…) The tools used to elicit risk attitude and risk preferences over time can ben divided into two categories. The first, relying on economic/quantitative measurement, draws from the theoretical framework of classical economics and/or behavioural finance and from experimental economics. The second category is based on psychology and psychometrics, that is, the field of study concerned with the theory and techniques of psychological measurement, which includes the measurement of knowledge, abilities, attitudes and personality traits (so-called constructs).