Correlation Neglect in Financial Decision-Making
AbstractGood decision-making often requires people to perceive and handle a myriad of statistical correlations. Notably, optimal portfolio theory depends upon a sophisticated understanding of the correlation among financial assets. In this paper, we examine people's understanding of correlation using a sequence of portfolio-allocation problems and find it to be strongly imperfect. Our experiment uses pairs of portfolio-choice problems that have the same asset span - identical sets of attainable returns - and differ only in the assets' correlation. While any outcome-based theory of choice makes the same prediction across paired problems, subjects behave very differently across pairs. We find evidence for correlation neglect - treating correlated variables as uncorrelated - as well as for a form of "1/N heuristic" - investing half of wealth each of the two available assets.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 1104.
Length: 41 p.
Date of creation: 2011
Date of revision:
Portfolio choice; correlation neglect; 1/n heuristic; biases in beliefs;
Find related papers by JEL classification:
- B49 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Other
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-02-26 (All new papers)
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Daniel Gottlieb & Kent Smetters, 2012. "Narrow Framing and Life Insurance," NBER Working Papers 18601, National Bureau of Economic Research, Inc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Bibliothek).
If references are entirely missing, you can add them using this form.