Risk Willingness and Perceived Utilities to Explain Risky Investment Choices: A Behavioral Model

Abstract

The author develops a descriptive behavioral model to explain investment choices in risky assets. Relative to many expected utility theories, the model has advances in some concepts: (a) integrated risk preferences along a continuum of risk willingness, with specific considerations to probabilities of both gains and losses, thus distinguishing risk-averse from risk-venturous investors; (b) third and fourth order of risk preferences corresponding to third and fourth moments of distributions of asset returns; (c) heterogeneous perceived utilities with utilitarian, hedonic, social, and risk-willing dimensions; and (d) risk-willing utilities functions for gains and losses, specifically to explain the observed asymmetries in risk preferences between them. The author discusses the qualitative factors that affect investors’ behavior in risky choices, but still explains their decisions with the traditional concept of utilities. The author validates his model qualitatively against Tversky and Kahneman’s [1992] criteria of an adequate descriptive theory of choice before he concludes.

Keywords:

• Risk willingness
• Integrated risk preferences
• Perceived utilities

Acknowledgments

Ms. Veronica Lukman’s expertise to compose Figure 1 in the article is much appreciated.