RISK TOLERANCE ANALYSIS: ROMANIAN CASE BEFORE AND DURING FINANCIAL TURMOIL

ABSTRACT. One of the most challenging problems of investment theory is to explain and to understand the risk behaviour of people interested in investing their savings on the stock exchange. The recent global financial crisis significantly affected public perception about the risks and had a direct impact on the transaction volume and type of operations performed on international capital markets. Risk tolerance is considered in crisis theories as one of the major factors inducing global contagion. Social aspects like gender, social status, level of income (wealth) are considered to be relevant for explaining risk tolerance. This research proposed a specific instrument used to test the level of risk aversion (inverse of risk tolerance) applied on the Romanian case in two different periods (before crisis and during crisis) and on a statistically relevant sample of respondents. Using specific tools (non-parametric and parametric instruments), the paper provides a closer insight on this specific problem, trying to explain the significance of different social aspects on the risk aversion level for different categories, but also to explain how the crisis affected this aversion.JEL Classification: A13, G12, D53, D81, G01Keywords: risk aversion, behavioural finance, optimal portfolio investments, capital market, investment criteria(ProQuest: . denotes formulae omitted.)IntroductionRisk attitude is important for explaining why a potential investor is interested or not to introduce money on capital markets and for determining the amount of money invested (if the decision will be in favour of investments). According with mainstream approach (the research was initiated by Pratt, 1964; Arrow, 1971; continued by KihlstromM followed recently by Borghans et al., 2009; Kraeussl, et al., 2010 and Ruble, 2011), the investors could adopt three different attitudes toward investment risk: aversion, indifference and preference. Different utility functions are associated to expected returns (using probabilities), in order to explain these attitudes (risk aversion meaning that the investors will associate a higher utility to the possibility of losing money from a risky investment alternative compared with those investors that prefer the risk and therefore they associate a higher utility for potential gains than potential losses). There are families of utility functions proposed for describing such behaviours: logarithmic functions are used for describing risk aversion investors, linear functions for risk indifferent individuals and exponential functions for risk preferring investors (Wakker, 2008; Wurth& Schumacher, 2011). These utility functions of investors' wealth are used to estimate the parameter of absolute risk aversion (ARA) and relative risk aversion (RRA). Absolute risk aversion is determined by the absolute amount of investor's income that she / he agrees to invest in a risky alternative and this absolute risk aversion is dependent on the changes in the income level - a decreasing absolute risk aversion means that the investor will increase the amount of money invested when his income will be higher, while an increasing absolute risk aversion means that the invested amount of money will be lower when the incomes will increase (there is also a constant absolute risk aversion reflecting no link between the increase of investor's wealth and the amount of money invested on the market). Comparatively, relative risk aversion expresses the willingness of an individual to invest his money in a risky alternative as a function of weight of the total wealth of this individual that is allocated in risky assets. A decreasing relative risk aversion means that an increase in the investor's income level will increase the weight of his wealth allocated in risky alternatives (or assets). …