New Research Questions Role of Risk in Investment Decision Making Process

SALT LAKE CITY—When it comes to the world of investments, many assume to win big one must risk big. Research from a University of Utah David Eccles School of Business professor shows risk may not be the best indicator of an investment’s potential for big returns.

In his paper, “The Critical Role of Conditioning Information in Determining if Value is Really Riskier than Growth,” Michael Cooper and co-author Stefano Gubellini demonstrate a lack of reliability—of CCAPMs (Conditional Capital Asset Pricing Models) in properly gauging risk and predicting the potential payoff from a financial investment.

Cooper says of CCAPMs, the models used to determine the theoretical appropriate required rate of return based off of non-diversifiable risk, “They leave a lot to be desired.” He continues, “Our research shows that 90 percent of the time no correlation exists between the perceived risk and actual payoff of an investment.”

CCAPMs are an accepted tool used in studying critical portfolio decisions, and yet can sometimes be too rigid in assessing acceptable risk tolerance in stocks and other investments, according to Cooper’s and Gubellini’s research. When such models fall short in predicting results, they can imperil long-term portfolio management and performance.

The study shows risk accounts for only 10 percent of an investment’s gain in either value or growth strategies. This finding leads Cooper to conclude that other factors outweigh risk in determining an investment’s potential level of returns.

Instead, Cooper says that “examining the historical performance, and gaining an understanding of how returns vary over time,” may be a better, simpler and more accurate way to evaluate the appropriate rate of return for an investment.

“The Critical Role of Conditioning Information in Determining if Value is Really Riskier than Growth,” was published in the Journal of Empirical Finance. Michael Cooper is a professor of Finance at the University of Utah’s David Eccles School of Business. Stefano Gubellini is a professor of Finance at San Diego State University,