Research On Domain Effects Of Risk Preference In Individual Financial Decisions

Financial decisions are very common in our daily lives, and are greatly influenced by risk preference. It is very helpful for financial institutes to understand investor risk preferences, since they need to carry out investor adequacy management policy and cater to investor risk preference by developing new and different products.Whether risk preference is a consistent personality has aroused interest of many decision researchers. Weber (2002) is the first to propose that risk behaviors would change according to domains, and developed a Domain-specific risk-taking scale including five domains from health care to investment. A large number of followers supported his propositions by providing evidence against risk preference stability through learning effects. These researches were based on risk-return framework, and studied different domains but lacked the further study of sub-domains. This paper studied financial domains and people’s risk preference differences.The emerging behavioral finance provided theoretical foundations for lots of unexplained phenomena in tradition Expected Utility Theory, showing that decisions are influenced by cognitive biases. Kahneman&Tversky(1979,1992) were co-founders of behavioral finance and proposed the famous Prospect Theory, of which loss aversion is an important factor. When facing gain prospects, people show risk aversion, however, when facing loss prospects, they behave in a risk-seeking manner. Loss aversion not only was found in Asian Disease Experiment, but also explained Endowment Effects, Status Quo Bias and Non-stock investor phenomena. Then, would loss aversion resolve the domain effects in risk preferences? Can different domains be classified as different prospects in loss aversion? These are problems this paper discussed about.This paper studied domain effects in financial risk preferences, and provided explanations based on loss aversion of prospect theory. Through experiment designs of seven domains (gain gamble, loss gamble, investment, insurance, pensions, salary and mortgage), this paper studied risk preferences in different financial sub-domains and got following conclusions:Firstly, risk preference differs under different domains, reflecting domain effects of risk preference. Secondly, by principal factor analysis, this paper has got two factors from seven domain variables. Due to relevance to potential gains, gain gambles, salary, pension, investment and mortgage are classified as Gain Domain Factor. And, due to relevance to potential losses, insurance and loss gambles are classified as Loss Domain Factor. Thirdly, risk preferences under the two domain factors are different, which can be explained by loss aversion. In gain domains, people show risk aversion, while in loss domains, people show risk seeking. Lastly, male and female are not different with loss aversion attitude. Although men and women both present loss aversion in loss and gain domains, gender difference of risk preference under the same domain is not significant. This might be due to socialization of both gender. In the end, this paper provided some future directions.