Behavioral finance FAQ / Glossary (Risk perception)
This is a separate page of the P-Q section of the Glossary
Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
Perceived risk, risk perception
03/10i - 06/11i - 10/5i
+ see perception, risk
When risk is a matter of taste.
Risk perception is a subjective appraisal of risk .
Often, the perceived risk
can be the opposite of the real risk,
or can differ widely from it by underestimating or overestimating it.
or is fully illusive in cases of uncertainty (see that word), in which
the risk cannot be really known.
The risk can then be overstated or, on the contrary, explanations
are invented to create pseudo certainties that avoid the anguish.
How such misperception happen?
Although this biased understanding might be more widespread among
people in the street than among specialists, it is not an absolute and
general rule, as specialists might be prisoners of their narrow paradigms
People (and among them investors):
Tend to neglect real probabilities, even when a flurry of
reliable statistics exists (see "base rate fallacy").
Or, on the other hand, tend to trust data that are flawed, reductive or
obsolete (see numeracy bias, range estimate aversion).
Investment and risk perception
When hope and fear meddle in risk calculation.
Risk perception might be a more important factor than real risk in
market prices and returns!
Actually, investors tend to ignore the level of the real risk (supposing that
it might be known via statistic or estimated via scenario building...).
That makes them often:
Overestimate or underestimate
either the potential rewards or the potential risk.
Adorn it, in an apparent rationality (see rationalization),
with their tastes (positive or negative feelings) by tinkering
with their risk / rewards estimates. Thus,
When, they have, towards
an asset, a positive
They rationalize their
impression by seeing
the desired asset as
highly beneficial and
When they have a
They rationalize by
considering it at the same
time risky and offering
Those biases can be contagious, affect then many investors and
explain various outlandish market phenomena: the average level of the equity
premium, the alternation of bubbles and crashes...
This does not mean we should
always shun assumptions.
Obviously, when facing new or rare events, for which reliable statistics
and probabilities do not exist, deciders have to start from what they
perceive, so as to make assumptions about the odds.
=> Here, the potential for subjectivity and irrational perception is high.
But there are methods (see Bayes) to try to adjust progressively
those assumptions to realities
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This page last update: 19/07/15