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How to Alleviate Correlation Neglect in Investment Decisions

Author

Listed:
  • Christine Laudenbach

    (Leibnitz Institute for Financial Research Sustainable Architecture for Finance in Europe, D-60323 Frankfurt am Main, Germany)

  • Michael Ungeheuer

    (Department of Finance, Aalto University, FI-00076 Aalto, Finland)

  • Martin Weber

    (University of Mannheim, School of Business, D-68131 Mannheim, Germany; Centre for Economic Policy Research, London EC1V 3PZ, United Kingdom)

Abstract

We experimentally study how presentation formats for return distributions affect investors’ diversification choices. We find that sampling returns alleviates correlation neglect and constitutes an effective way to improve financial decisions. When participants get a description of the probabilities for outcomes of the joint return distribution, we confirm the findings of others that investors neglect the correlation between assets in their diversification choices. However, when participants sample from the joint distribution, they change their allocation between two assets in response to a change in their correlation in the predicted direction. The results are robust across two experiments that have participants with varying experience (students versus private investors).

Suggested Citation

  • Christine Laudenbach & Michael Ungeheuer & Martin Weber, 2023. "How to Alleviate Correlation Neglect in Investment Decisions," Management Science, INFORMS, vol. 69(6), pages 3400-3414, June.
    • Handle: RePEc:inm:ormnsc:v:69:y:2023:i:6:p:3400-3414
    DOI: 10.1287/mnsc.2022.4535
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