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Irrational Diversification: An Examination of Individual Portfolio Choice

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  • Baltussen, Guido
  • Post, Gerrit T.

Abstract

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.

Suggested Citation

  • Baltussen, Guido & Post, Gerrit T., 2011. "Irrational Diversification: An Examination of Individual Portfolio Choice," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(05), pages 1463-1491, November.
  • Handle: RePEc:cup:jfinqa:v:46:y:2011:i:05:p:1463-1491_00
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    Cited by:

    1. Sandro Ambuehl & B. Douglas Bernheim & Annamaria Lusardi, 2014. "A Method for Evaluating the Quality of Financial Decision Making, with an Application to Financial Education," NBER Working Papers 20618, National Bureau of Economic Research, Inc.

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