Lower partial moments as measures of perceived risk: An experimental study

The paper reports the results of an experiment on individual investors' ris k perception in a financial decision making context under two different mod es of information presentation (framings). One way to reduce the complexity of a risky decision situation is to focus on risk measures, e.g. the stati stical moments of a risky alternative's distribution. There is a huge numbe r of propositions about which risk measure is to be used from a theoretical point of view. Many of these models are based on the variance as risk meas ure. But since the symmetrical nature of variance does not capture the comm on notion of risk as something undesired there has been much discontent wit h this approach. More recently, lower partial moments (LPMs) have been redi scovered as a more suitable risk measure. They reflect the popular negative meaning of risk since they only take negative deviations from a reference point to measure risk. The purpose of this paper is to examine experimentally people's risk percep tion in a financial context. The focus is on the correspondence of risk per ceptions with specific LPMs. The main findings can be summarized as follows . First, symmetrical risk measures like variance can be dearly dismissed in favor of shortfall measures like LPMs. Second, the reference point (target ) of individuals for defining losses is not a distribution's mean but the i nitial price LPM0. i.e. the probability of loss. Fourth, the framing of pri ce distributions (histograms versus charts) exerts a significance influence on average risk ratings, the latter being higher for the histogram framing . Fifth, positive deviations from an individual reference point tend to dec rease perceived risk. (C) 2000 Elsevier Science B.V. All rights reserved. P sycINFO classification: 3920 JEL classification: C91; D81; G19.