Effectively managing the behavioral side of risk to enhance performance
There is no ‘’right’’ attitude towards risk. Nevertheless, some attitudes are more appropriate to a particular task, function or business outlook. Serial entrepreneurs tend to be comfortable with a certain risk level while on-going business managers tend to be risk averse. Such individual attitudes are rarely impacted by risk decision making processes and metrics. How many CEOs have tried to induce more risk taking behavior to foster innovation, without much impact? How many senior executives in the financial industry have significantly reinforced control systems and yet, are still concerned by irrational behaviors of traders? The ability to capture these individual attitudes can then become a powerful lever of performance for most businesses, including financial institutions.
Risk-taking behaviors are influenced by a tangle of cognitive biases
In line with the famous Prospect Theory by D. Kahneman, three main factors involved in risk-taking behaviors have been studied over the last three decades:
Risk perception, which relates to how individuals implicitly evaluate the probability of an event
Risk preference, which relates to the preference for a risky, uncertain payment over a certain payment
Loss aversion, which relates to the aversion for negative outcomes
Numerous cognitive biases can influence these three parameters. Most of them are unconscious and are generated by our system 1 of thinking. They result from our immediate environment, our corporate culture and our individual past experiences. Some of them have a contingent impact on our attitude towards risk such as following the decisions of other investors to make investment (herding effect). Others have a stable impact like overconfidence, self-esteem or overoptimism.
The challenge: surfacing and measuring the cognitive biases involved in risk-taking behaviors to instigate behavioral change and best manage risk positions
People are rarely aware of their actual risk attitudes and their impact on their decisions. If you are asked to evaluate on a 10-point scale the strength of your risk-aversion, you will face many problems to interpret them. First, you may unconsciously adapt your answer to what is expected from you in term of function and sector. Second, you may be unable to evaluate introspectively your own risk-aversion. Third, you may be influenced by other biases such as your preference for extreme or medium ratings –just as for other types of self-assessments.
The best way to address these issues is to use highly sophisticated yet practical tools which directly target our unconscious way of thinking, the system 1 so as to surface even cognitive biases we are not aware of.
That is why we have developed, based on the latest advances in mind sciences, the Risk CogPIT™. It evidences potential discrepancies between explicit and implicit risk attitudes and quantifies the strength of potential main cognitive biases affecting risk perception, risk preference and loss aversion. It is the first step to instigate behavioral change when needed.
The Risk CogPIT™ is an effective tool to manage teams’ risk related profiles