Saturday, April 21, 2018
Risk-taking - Is it nature or nurture? - You may not be able to escape your past
Why are some investors risk takers and others are not? Is risk-taking something that can be taught or is it innate? Risk-taking – is it nature or nurture?
These are important questions that have an impact on how investors build portfolios and how they will grow wealth. Most researchers have often avoided these questions because they are difficult to test. Economics will describe the behavior of risk-takers and those who are risk averse, but there is little discussion on how individuals got these characteristics.
A recent Journal of Finance “On the Origins of Risk-Taking in Financial Markets” (October 2017) by Sandra Black, Paul Devereux, Petter Lundborg, and Kaveh Majleski looks at this issue through striding the behavior of Swedish adoptees and makes some interesting conclusions. The environment dominates genetics however they both play a role. Intergenerational transfer of risk-taking and asset allocation behavior exists. Children are taught or learn how to be risk-takers from their parents. Those risk-takers are willing to skew their portfolio allocations to equities and thus are able to grow wealth faster than others. Perhaps risk-taking traders are that way because they grew-up in an environment that allowed for more risk-taking?
From my quant bias, it tells me that allowing models to help with the decision process will allow innate risk preferences to be over-ridden. There is no value judgment on this transfer effect of nurturing, but appreciating its existence allows for adjustments in behavior.