Risk measure optimization: Perceived risk and overconfidence of structured product investors

Abstract

In financial optimization, it is important to quantify the risk of structured financial products. This paper quantifies the risk of structured financial products by perceived risk measures based on a standard measure of risk, and then we construct the risk perception and decision-making models of individual investors considering structured products. Moreover, based on bullish and bearish binary structured products, we introduce the psychological bias of overconfidence to explore how this bias affects investors' perceived risk. This study finds that overconfident investors believe in private signals and underestimate the variance of noise in private signals, which affects their expectation of the underlying asset price of structured financial products. Furthermore, overconfidence bias leads investors to overestimate the probability of obtaining a better return. With the increase in overconfidence, the overestimation of the probability is intensified, which eventually leads to lower perceived risk.