Defining and Measuring Risk Capacity

Defining and Measuring Risk Capacity

Academy of Financial Services, Las Vegas

Fall 2011 (Best Paper Award Winner) and published in the Financial Services Review 2012 

Abstract

New generation models of assessing a client’s profile for investment purposes differentiates among factors like the client’s tolerance for risk which is a psychological trait, the client’s required risk which is a how much risk a client might be required to take to achieve desired goals, and risk capacity which is how much risk the client can afford to take. Risk tolerance assessments have taken significant strides forward with the introduction of psychometrics, but when it comes to defining risk capacity, the approach remains anecdotal. Client profiling questionnaires may ask one or two questions like “How much risk can you afford to take?”, but what is “risk capacity” and how do we measure it?

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