Financial Risk Tolerance: Where Does It All Start From?

Abstract

This chapter introduces the relevance of the debate on financial risk tolerance starting from reconstructing the key macroeconomic changes that progressively expanded the investor base in Europe and beyond starting in the 1990s, focusing both on financial markets and on other relevant sectors. The increased investment opportunities available to the retail investor expanded potential opportunities for financial gain for individuals but also highlighted the need to provide clear guidelines to structure and shape these opportunities considering all the risks. The need to govern this important change in financial markets favored the convergence of different disciplines on the importance of financial risk tolerance: regulation, academia, and practitioners were all called upon figuring out how to measure this somewhat elusive concept. This chapter focuses on the period prior to the introduction of the Markets in Financial Instruments Directive (MiFID) in Europe when financial advisory was not yet considered a proper financial service and investors were still transitioning from direct holdings of stock to more flexible tools like mutual funds. Besides briefly describing the regulatory framework, a literature review of risk tolerance measurement and drivers is provided, to conclude with a practitioner’s view regarding the relevance of risk tolerance measurement in this period.