Diego Rossano, Alessandro Sapio

Investor risk profiling: Regulatory perspectives from experimental economics

  • Abstract

Informations and abstract

Keywords: Risk Profiling; Risk Aversion; Cognitive Bias; Experimental Economics; Financial Regulation.

The present study explores the main features of the cognitive processes involved in decision-making by investors, drawing on frontier studies in behavioral and experimental economics. After highlighting the main deviations of investment decisions from the case of perfect rationality, traditionally assumed by economic theory, the paper outlines implications for the study of the circumstances that influence the financial risk perception of the investors (whether they are experts or not), whence the examination of the regulatory instruments that are better able to allow a reliable evaluation of the risk attitudes, by financial intermediaries, of their clients, as mandated for instance by the MiFID regulation. It is indeed highly interesting from a policy perspective to identify the expedients suitable to reduce the exploitation of cognitive effects by unscrupulous parties to the detriment of clients in credit and financial relationships, as well as the techniques that may allow intermediaries to carry out an unbiased profiling of risk tolerance, based on a correct exchange of information. Our investigation is further aimed at verifying if, instead, with the introduction of recent disciplinary measures such as MiFID II and Mifir, regulators have born in mind the results from the cognitive studies on risk perception. The doubt still exists, however, that intermediaries, on the level of concreteness, are only required to guarantee the formal respect of the rules. Therefore, the research discusses the suitability of the current regulations and tackles the main challenges ahead, concerning the context in which financial communication and negotiation occur, the neutrality of subjects who define the context and supply information, the accessibility of unbiased information and the provision of an appropriate time for information processing and decision making. Moreover, we propose regulatory instruments that, in this context, could be more effective and fair than the existing ones in light of the cognitive distortions from which investors normally fall victim.

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