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Investment Decisions and Time Horizon: Risk Perception and Risk Behavior in Repeated Gambles

  • Alexander Klos

    ()

    (Lehrstuhl für Bankbetriebslehre, L 5,2, Universität Mannheim, 68131 Mannheim, Germany)

  • Elke U. Weber

    ()

    (Center for Decision Sciences and Graduate School of Business, Columbia University, 3022 Broadway, 716 Uris Hall, New York, New York 10027)

  • Martin Weber

    ()

    (Lehrstuhl für Bankbetriebslehre, L 5,2, Universität Mannheim, 68131 Mannheim, Germany, and CEPR, 90-98 Goswell Road, London EG1V 7RR, United Kingdom)

To investigate the effect of time horizon on investment behavior, this paper reports the results of an experiment in which business graduate students provided certainty equivalents and judged various dimensions of the outcome distribution of simple gambles that were played either once or repeatedly for 5 or 50 times. Systematic mistakes in the ex-ante estimations of the distributions of outcomes after (independent) repeated plays were observed. Despite correctly realizing that outcome standard deviation increases with the number of plays, respondents showed evidence of Samuelson's (1963) fallacy of large numbers. Perceived risk judgments showed only low correlations with standard deviation estimates, but were instead related to the anticipated probability of a loss (which was overestimated), mean excess loss, and the coefficient of variation. Implications for future research and practical implications for financial advisors are discussed.

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File URL: http://dx.doi.org/10.1287/mnsc.1050.0429
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Article provided by INFORMS in its journal Management Science.

Volume (Year): 51 (2005)
Issue (Month): 12 (December)
Pages: 1777-1790

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Handle: RePEc:inm:ormnsc:v:51:y:2005:i:12:p:1777-1790
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  1. Klos, Alexander, 2004. "The Investment Horizon and Dynamic Asset Allocation - Some Experimental Evidence," Sonderforschungsbereich 504 Publications 04-09, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
  2. Elke U. Weber & Christopher Hsee, 1998. "Cross-Cultural Differences in Risk Perception, but Cross-Cultural Similarities in Attitudes Towards Perceived Risk," Management Science, INFORMS, vol. 44(9), pages 1205-1217, September.
  3. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  4. Langer, Thomas & Weber, Martin, 2005. "Myopic prospect theory vs. myopic loss aversion: how general is the phenomenon?," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 25-38, January.
  5. Sarin, Rakesh K. & Weber, Martin, 1993. "Risk-value models," European Journal of Operational Research, Elsevier, vol. 70(2), pages 135-149, October.
  6. Shlomo Benartzi & Richard H. Thaler, 1999. "Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments," Management Science, INFORMS, vol. 45(3), pages 364-381, March.
  7. Elke U. Weber & Richard A. Milliman, 1997. "Perceived Risk Attitudes: Relating Risk Perception to Risky Choice," Management Science, INFORMS, vol. 43(2), pages 123-144, February.
  8. Donald L. Keefer & Samuel E. Bodily, 1983. "Three-Point Approximations for Continuous Random Variables," Management Science, INFORMS, vol. 29(5), pages 595-609, May.
  9. Shlomo Benartzi & Richard H. Thaler, 2002. "How Much Is Investor Autonomy Worth?," Journal of Finance, American Finance Association, vol. 57(4), pages 1593-1616, 08.
  10. Alexander Klos & Martin Weber, 2006. "Portfolio Choice in the Presence of Non-Tradable Income: An Experimental Analysis," German Economic Review, Verein für Socialpolitik, vol. 7, pages 427-448, November.
  11. Klos, Alexander, 2004. "The investment horizon and dynamic asset allocation--some experimental evidence," Economics Letters, Elsevier, vol. 85(2), pages 167-170, November.
  12. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  13. Michael Kilka & Martin Weber, 2001. "What Determines the Shape of the Probability Weighting Function Under Uncertainty?," Management Science, INFORMS, vol. 47(12), pages 1712-1726, December.
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