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Adaptive behavior leads to under-diversification

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  • Zion, Uri Ben
  • Erev, Ido
  • Haruvy, Ernan
  • Shavit, Tal

Abstract

In a given period, a diversified fund, by virtue of being a weighted average, will perform somewhere in the middle range of its components' respective performances. This means that adaptive investors who look to the past to adjust expectations about future returns will shun diversified funds. That is, adaptive reaction to feedback implies under-diversification when the investor gets complete feedback on the performance of the diversified fund as well as its components in a given period. Three laboratory experiments and one quasi field experiment explore this possibility and its implications. We find that the availability of complete feedback drastically reduces diversification. Under-diversification is observed even when the decision makers receive a complete description of the payoff distributions and when under-diversification lowers expected return.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Psychology.

Volume (Year): 31 (2010)
Issue (Month): 6 (December)
Pages: 985-995

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Handle: RePEc:eee:joepsy:v:31:y:2010:i:6:p:985-995

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Web page: http://www.elsevier.com/locate/joep

Related research

Keywords: Diversification Learning Adaptation;

References

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Citations

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Cited by:
  1. Eyal Ert & Ido Erev, 2013. "On the descriptive value of loss aversion in decisions under risk: Six clarifications," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 8(3), pages 214-235, May.
  2. Benzion, Uri & Krupalnik, Lena & Rosenfeld, Ahron & Shahrabani, Shosh & Shavit, Tal, 2012. "The effect of short-term information on long-term investment: An experimental study," Economics Letters, Elsevier, vol. 116(1), pages 20-22.
  3. Malul, Miki & Rosenboim, Mosi & Shavit, Tal, 2013. "So when are you loss averse? Testing the S-shaped function in pricing and allocation tasks," Journal of Economic Psychology, Elsevier, vol. 39(C), pages 101-112.

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