AbstractMultiplicative growth processes that are subject to random shocks often have a skewed distribution of outcomes. A simple laboratory experiment shows that participants either strongly underestimate skewness or ignore it completely. The participants' choices reveal bounds on their subjective medians of a financial asset's price that is subject to stochastic growth. The observed bias in expectations is irrespective to risk preferences and fairly robust to feedback. It is consistent with a behavioral model in which geometric growth is confused with linear growth. The bias is a possible explanation of investors' misunderstandings of real-world financial products like leveraged ETFs.
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Bibliographic InfoPaper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 1238.
Length: 16 : Anh. p.
Date of creation: 2012
Date of revision:
Skewness; belief biases; binomial tree;
Other versions of this item:
- Ludwig Ensthaler & Olga Nottmeyer & Georg Weizsäcker, 2010. "Hidden Skewness," Discussion Papers of DIW Berlin 1043, DIW Berlin, German Institute for Economic Research.
- Ensthaler, Ludwig & Nottmeyer, Olga & Weizsäcker, Georg, 2010. "Hidden Skewness," IZA Discussion Papers 5109, Institute for the Study of Labor (IZA).
- C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
- D03 - Microeconomics - - General - - - Behavioral Economics; Underlying Principles
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-09 (All new papers)
- NEP-EXP-2012-09-09 (Experimental Economics)
- NEP-UPT-2012-09-09 (Utility Models & Prospect Theory)
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- Klaus Abbink & Bettina Rockenbach, 2006. "Option pricing by students and professional traders: a behavioural investigation," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 27(6), pages 497-510.
- Victor Stango & Jonathan Zinman, 2009. "Exponential Growth Bias and Household Finance," Journal of Finance, American Finance Association, vol. 64(6), pages 2807-2849, December.
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- Alexander Klos & Elke U. Weber & Martin Weber, 2005. "Investment Decisions and Time Horizon: Risk Perception and Risk Behavior in Repeated Gambles," Management Science, INFORMS, vol. 51(12), pages 1777-1790, December.
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