Downside financial risk is misunderstood

Citation

Newall PWS (2016) Downside financial risk is misunderstood. Judgement and Decision Making, 11 (5), pp. 416-423. http://journal.sjdm.org/16/16222/jdm16222.pdf

Abstract
The mathematics of downside financial risk can be difficult to understand: For example a 50% loss requires a subsequent 100% gain to break-even. A given percentage loss always requires a greater percentage gain to break-even. Instead, many non-expert investors may assume for example that a 50% gain is sufficient to offset a 50% loss. Over 3,498 participants and five experiments, the widespread illusion that a sequence of equal percentage gains and losses produces a zero overall return was demonstrated. Participants continued to err frequently, even with percentage returns of +/-100%, or when financially incentivized. Financial literacy, numeracy, and deliberation were all shown to independently contribute to accurate performance. These results have implications for promoting the understanding of downside financial risk.

Keywords
financial risk; downside risk; numeracy; percentages; financial literacy; deliberation

Journal
Judgement and Decision Making: Volume 11, Issue 5

• jdm16222.pdf