Project Description

Setting the Groundwork for Better Measures of Financial Risk Tolerance

Professor Shachar Kariv was recently published by the International Banker on his groundbreaking developments in Setting the Groundwork for Better Financial Measures.

Executive Summary

Given that individuals differ in their financial decision-making abilities (DMA), there are important differences between the financial choices that some people make and the choices they would make if they had the knowledge to make better decisions. In our research, we define and assess decision-making quality (DMQ) by evaluating how well financial decisions in a controlled experiment comply with the principle of individual utility maximization. We introduce an experimental technique that allows the rapid collection of large amounts of choice data that permit a stringent test of utility maximization. Among our main findings is that younger, higher-income and higher-education individuals display greater levels of DMA than older, lower-income and lower-education individuals. We also find that the quality of choices in the experiment is strongly related to wealth: a standard deviation increase in DMQ in the experiment is associated with 15-19 percent more household wealth. Our measure of DMQ under laboratory conditions thus captures DMA that applies across domains and influences important real-world outcomes. The question is: What might this mean for the world of finance?

 

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Professor Shachar Kariv
Professor Shachar KarivChief Scientist & Co-Founder