An environment test for risk tolerance assessment verification in lifelong financial planning for households

Abstract

Purpose: The aim of this study is to propose and discuss a theoretical framework of a testing environment for verification of household risk tolerance assessment methods, based on a financial plan optimization model. It is intended to be suited to the specificity of life-long financial planning for households. Design/Methodology/Approach: The assumption of the proposed testing environment is that a risk tolerance measure should be used as part of the input to a household life-long financial plan optimization procedure. The risk of the received plan should therefore be consistent with the risk tolerance estimated at the beginning. Findings: After the analysis of the structure of the existing financial plan optimization model (developed by the Authors as part of some former research project) it has been concluded that, after some modifications, it is possible to use it as a test environment for verification of household risk tolerance assessment methods. Practical Implications: The possibility of verification of a risk tolerance assessment method for a household life-long financial plan is necessary to be able to construct plans that are really suited to household needs. So far, there do not exist proper household risk aversion measures, nor methods of household risk aversion estimation, that would consider the nature of risk that is present in the household life-long financial planning. But as soon as such methods are developed, it will be necessary to be able to verify whether the risk tolerance estimates obtained from them are at all reliable and if they are in line with how households understand their risk tolerance. Originality/Value: This study is a step towards verifying household risk tolerance models for lifetime financial plans, which is a new research area, not yet undertaken in the literature. It is very important both from the point of view of the further development of the theory of personal finance and for the practice of financial planning.