Irrational Diversification: An Examination of Individual Portfolio Choice

We study individual portfolio choice in a laboratory experiment and find strong evidence for heuristic behavior. The subjects tend to focus on the marginal distribution of an asset, while largely ignoring its diversification benefits. They follow a conditional 1/n diversification heuristic as they e...

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Bibliographic Details
Published inJournal of financial and quantitative analysis Vol. 46; no. 5; pp. 1463 - 1491
Main Authors Baltussen, Guido, Post, Gerrit T.
Format Journal Article
LanguageEnglish
Published New York, USA Cambridge University Press 01.10.2011
Subjects
Allocative efficiency
Asset allocation
Assets
Diversification
Dominance
Financial investments
Financial portfolios
Heuristic
Heuristics
Investment risk
Investors
Lotteries
Portfolio diversification
Portfolio management
Quantitative analysis
Test
Yield
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ISSN0022-1090
1756-6916
DOI10.1017/S002210901100041X

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Summary:We study individual portfolio choice in a laboratory experiment and find strong evidence for heuristic behavior. The subjects tend to focus on the marginal distribution of an asset, while largely ignoring its diversification benefits. They follow a conditional 1/n diversification heuristic as they exclude the assets with an “unattractive” marginal distribution and divide the available funds equally between the remaining “attractive” assets. This strategy is applied even if it leads to allocations that are dominated in terms of first-order stochastic dominance and is clearly irrational. In line with these findings, we find that framing and problem presentation have substantial influence on portfolio decisions.
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ISSN:0022-1090
1756-6916
DOI:10.1017/S002210901100041X