Risk tolerance and household financial behaviour: A test of the reflection effect

An important proposition underlying prospect theory is the notion that when decision-makers must choose between options with gains and losses, their preference for positive outcomes often mirrors their preference for negative outcomes. This is called the reflection effect. This paper aimed to test the extent to which the reflection effect is associated with household finance outcomes. A secondary goal was to determine whether different risk preference groups, based on categorised reflection effect responses (i.e. risk avoiders, loss averse, loss tolerant and risk seekers), share common demographic characteristics. Findings, based on internet survey data from more than 40,000 individuals aged 35 or older, showed that individuals, on average, exhibit the reflection effect. The results also confirmed that there are differences in behaviour across risk categories, but that it is difficult to cluster decision-makers into a risk category using demographic characteristics.