On perceptions of financial volatility in price sequences

Abstract

Stock prices in financial markets rise and fall, sometimes dramatically, thus asset returns exhibit volatility. In finance theory, volatility is synonymous with risk and as such represents the dispersion of asset returns about their central tendency (i.e. mean), measured by the standard deviation of returns. When individuals make investment decisions, influenced by perceptions of risk and volatility, they commonly do so by examining graphs of historic price sequences rather than returns. It is unclear, therefore, whether standard deviation of return is foremost in their mind when making such decisions. We conduct two experiments to examine the factors that may influence perceptions of financial volatility, including standard deviation along with a number of price-based factors. Also of interest is the influence of price sequence regularity on perceived volatility. While standard deviation may have a role to play in perception of volatility, we find evidence that other price-based factors play a far greater role. Furthermore, we report evidence to support the view that the extent to which prices appear irregular is a separate aspect of volatility, distinct from the extent to which prices deviate from central tendency. Also, while partially correlated, individuals do not perceive risk and volatility as synonymous, though they are more closely related in the presence of price sequence irregularity.

What makes an investment risky? An analysis of price path characteristics

“…Using other presentation formats than price paths, prior studies have shown that individuals often do not perceive the overall volatility as risk, but rather shortfall measures such as the probability of incurring a loss (Unser, 2000;Zeisberger, 2018;Holzmeister et al, 2019). Our findings support prior studies which identify that the standard deviation of returns is not the primary factor influencing investor risk perception in price path settings (Duxbury & Summers, 2018;Grosshans & Zeisberger, 2018;Nolte & Schneider, 2018).…”

“…Pincus and Kalman (2004) argue that irregularity in a price series changes perceived risk compared to regular, stylized series. Duxbury and Summers (2018) confirm these findings by showing that introducing irregularity to stylized series significantly increases perceived risk. As real-world price series usually display a high degree of irregularity, it adds value to stay close to realistic price paths to credibly identify the effect of price patterns on investor risk perception.…”

“…Higher run lengths of up-and downward trends, which lead to more extreme highs and lows, increase risk perception (Raghubir & Das, 2009;Grosshans & Zeisberger, 2018). Duxbury and Summers (2018) display stylized price sequences to experimental participants and determine that 1 Electronic copy available at: https://ssrn.com/abstract=3392623 price volatility rather than return volatility drives risk perception. 1 They identify that price-based factors, such as the number of peaks or the number of accelerated changes in direction within the price sequence, have a higher explanatory power.…”

Are investors consistent in their trading strategies? An examination of individual investor-level data

“…falling prices and negative returns). Thus the adoption of momentum trading strategies when buying might be driven by a desire to reduce perceived risk or volatility (see Duxbury and Summers, 2017, for further discussion on how price sequences inform perceptions of risk and volatility, along with evidence that the two are not necessarily synonymous), with momentum buying perceived as lower risk than contrarian buying. Such an explanation, based on experimental findings in studies not confined to Chinese participants, would suggest the asymmetry of trading strategies across buy and sell decisions we report here need not be restricted to Chinese investors, but might hold more generally.…”

C: Financial Operations and Services

“…168, no. 1108(May 2018 The number of bank branches per 100,000 adults in the EU fell by 28.7 per cent over the period [2009][2010][2011][2012][2013][2014][2015][2016]. Meanwhile, in excess of 1,700 branches closed in the US in the year to June 2017.…”