Adaptive behavior leads to under-diversification
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.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Fudenberg, Drew & Levine, David, 1998.
"Learning in games,"
European Economic Review,
Elsevier, vol. 42(3-5), pages 631-639, May.
- Drew Fudenberg & David K. Levine, 1998. "Learning in Games," Levine's Working Paper Archive 2222, David K. Levine.
- Ippolito, Richard A, 1992. "Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry," Journal of Law and Economics, University of Chicago Press, vol. 35(1), pages 45-70, April.
- De Bondt, Werner F M & Thaler, Richard H, 1990. "Do Security Analysts Overreact?," American Economic Review, American Economic Association, vol. 80(2), pages 52-57, May.
- James J. Choi & David Laibson & Brigitte C. Madrian & Andrew Metrick, 2009. "Reinforcement Learning and Savings Behavior," Journal of Finance, American Finance Association, vol. 64(6), pages 2515-2534, December.
- James Choi & David Laibson & Brigitte Madrian & Andrew Metrick, 2007. "Reinforcement Learning and Savings Behavior," Yale School of Management Working Papers amz2657, Yale School of Management, revised 01 Mar 2009.
- Metrick, Andrew & Laibson, David I. & Choi, James J. & Madrian, Brigitte, 2009. "Reinforcement Learning and Savings Behavior," Scholarly Articles 4686777, Harvard University Department of Economics.
- Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
- Judith A. Chevalier & Glenn D. Ellison, 1995. "Risk Taking by Mutual Funds as a Response to Incentives," NBER Working Papers 5234, National Bureau of Economic Research, Inc.
- Chevalier, J. & Ellison, G., 1996. "Risk Taking by Mutual Funds as a Response to Incentives," Working papers 96-3, Massachusetts Institute of Technology (MIT), Department of Economics.
- Erik R. Sirri & Peter Tufano, 1998. "Costly Search and Mutual Fund Flows," Journal of Finance, American Finance Association, vol. 53(5), pages 1589-1622, October.
- Statman, Meir, 1987. "How Many Stocks Make a Diversified Portfolio?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(03), pages 353-363, September.
- Blume, Marshall E & Friend, Irwin, 1975. "The Asset Structure of Individual Portfolios and Some Implications for Utility Functions," Journal of Finance, American Finance Association, vol. 30(2), pages 585-603, May.
- Drew Fudenberg & David K. Levine, 1998. "The Theory of Learning in Games," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061945, January.
- Drew Fudenberg & David K. Levine, 1996. "The Theory of Learning in Games," Levine's Working Paper Archive 624, David K. Levine.
- Ann-Renée Blais & Elke U. Weber, 2006. "A Domain-Specific Risk-Taking (DOSPERT)Scale for Adult Populations," CIRANO Working Papers 2006s-24, CIRANO.
- Ido Erev & Eyal Ert & Alvin E. Roth, 2010. "A Choice Prediction Competition for Market Entry Games: An Introduction," Games, MDPI, Open Access Journal, vol. 1(2), pages 1-20, May.
- Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
- Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
- De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
- Kelly, Morgan, 1995. "All their eggs in one basket: Portfolio diversification of US households," Journal of Economic Behavior & Organization, Elsevier, vol. 27(1), pages 87-96, June.
- Ann-RenÃ©e Blais & Elke U. Weber, 2006. "A Domain-Specific Risk-Taking (DOSPERT) scale for adult populations," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 1, pages 33-47, July.
- Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December.
- Brit Grosskopf & Ido Erev & Eldad Yechiam, 2006. "Foregone with the Wind: Indirect Payoff Information and its Implications for Choice," International Journal of Game Theory, Springer;Game Theory Society, vol. 34(2), pages 285-302, August.
- Valery Polkovnichenko, 2005. "Household Portfolio Diversification: A Case for Rank-Dependent Preferences," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1467-1502. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:eee:joepsy:v:31:y:2010:i:6:p:985-995. See general information about how to correct material in RePEc.
If references are entirely missing, you can add them using this form.