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Illusion of control as a source of poor diversification: An experimental approach

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Author Info
Gerlinde Fellner ()

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Abstract

This paper investigates factors influencing individual portfolio allocations with particular focus on the role of illusion of control. By forming their portfolio of two risky lotteries and one risk-less alternative, subjects are requested to reach a target investment profit, whereby equal diversification between the two risky lotteries is part of the solution space. Subjects however excessively invest in the lottery for which they can determine the outcome by rolling the die themselves indicating that they are prone to illusion of control. However, the effect vanishes with experience. In contrast, presenting random sequences of prior outcomes reduces biased investments. In line with the excessive extrapolation hypothesis, the more positive outcomes observed from past draws, the more likely is a positive prediction for this lottery, which is then followed by higher investment. Also, offering a default portfolio strongly determines final allocations.

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Paper provided by Max Planck Institute of Economics, Strategic Interaction Group in its series Papers on Strategic Interaction with number 2004-28.

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Length: 30 pages
Date of creation: May 2004
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Handle: RePEc:esi:discus:2004-28

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Related research
Keywords: Investment decisions; Portfolio selection; Egocentric biases; Illusion of Control; Experimental economics;

Find related papers by JEL classification:
C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
G00 - Financial Economics - - General - - - General
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

References listed on IDEAS
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    Other versions:
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