4. Financial Risk Perceptions: A Behavioral Perspective

The generally accepted financial risk metrics, such as variance and Beta, are axiomatic mathematical constructions. They have mathematical validity but can be questioned on behavioral grounds. This chapter suggests a broader alternative approach. First, perception involves experiential content acquired as a result of human/world interaction. It is not merely the product of a passive internal “brain process.” Second, financial risk is hypothesized to be primarily a perception of potential loss as fabricated by an evolutionary dual decision-making process that embraces both affect and formal cognitive analysis. Thus of necessity, perceptions of risk contain both cognitive and affective attributes. Because man is by nature a social creature, perceived risk also entails risk attributes that manifest group concerns. These hypotheses are supported by a comprehensive literature review. Evidence is presented suggesting that this alternative perspective parsimoniously explains many current “risk/return” market anomalies.