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Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

Author

Listed:
  • Stephen G Dimmock
  • Roy Kouwenberg
  • Olivia S Mitchell
  • Kim Peijnenburg

Abstract

We test whether probability weighting affects household portfolio choice in a representative survey. On average, people display inverse-S-shaped probability weighting, overweighting low probability events. As theory predicts, probability weighting is positively associated with portfolio underdiversification and significant Sharpe ratio losses. Analyzing respondents’ individual stock holdings, we find higher probability weighting is associated with owning lottery-type stocks and positively skewed equity portfolios. People with higher probability weighting are less likely to own mutual funds and more likely to either avoid equities or hold individual stocks. We are the first to empirically link individuals’ elicited probability weighting and real-world decisions under risk.

Suggested Citation

  • Stephen G Dimmock & Roy Kouwenberg & Olivia S Mitchell & Kim Peijnenburg, 2021. "Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field," The Review of Financial Studies, Society for Financial Studies, vol. 34(9), pages 4524-4563.
    • Handle: RePEc:oup:rfinst:v:34:y:2021:i:9:p:4524-4563.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhaa131
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    Cited by:

    1. Xue Dong He & Moris S. Strub & Thaleia Zariphopoulou, 2019. "Forward Rank-Dependent Performance Criteria: Time-Consistent Investment Under Probability Distortion," Papers 1904.01745, arXiv.org.
    2. Daniel Gottlieb & Olivia S. Mitchell, 2020. "Narrow Framing and Long‐Term Care Insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 87(4), pages 861-893, December.
    3. Liu, Yakun & Chen, Yan & Zhang, Lei & Deng, Xi, 2026. "Forecasting stock return: The role of idiosyncratic asymmetry risk," Journal of International Money and Finance, Elsevier, vol. 160(C).
    4. Thomas Epper & Helga Fehr-Duda, 2012. "The missing link: unifying risk taking and time discounting," ECON - Working Papers 096, Department of Economics - University of Zurich, revised Oct 2018.
    5. Glenn W. Harrison & Morten I. Lau & Hong Il Yoo, 2025. "Constant Discounting, Temporal Instability, And Dynamic Inconsistency In Denmark: A Longitudinal Field Experiment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 66(1), pages 363-392, February.
    6. Kanin Anantanasuwong & Roy Kouwenberg & Olivia S. Mitchell & Kim Peijnenburg, 2024. "Ambiguity attitudes for real-world sources: field evidence from a large sample of investors," Experimental Economics, Springer;Economic Science Association, vol. 27(3), pages 548-581, July.
    7. Dittmann, Ingolf & Montone, Maurizio & Zhu, Yuhao, 2023. "Wage gap and stock returns: Do investors dislike pay inequality?," Journal of Corporate Finance, Elsevier, vol. 78(C).
    8. Bertrand Candelon & Franz Fuerst & Jean-Baptiste Hasse Pages 126-139 Download PDF Data, Tools and Replication Section, 2021. "Diversification potential in real estate portfolios," International Economics, CEPII research center, issue 166, pages 126-139.
    9. Jun Yuan & Qi Xu & Ying Wang, 2023. "Probability weighting in commodity futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(4), pages 516-548, April.
    10. Chen, Rongxin & Lepori, Gabriele M. & Tai, Chung-Ching & Sung, Ming-Chien, 2022. "Can salience theory explain investor behaviour? Real-world evidence from the cryptocurrency market," International Review of Financial Analysis, Elsevier, vol. 84(C).
    11. Montone, Maurizio, 2023. "Beta, value, and growth: Do dichotomous risk-preferences explain stock returns?," Journal of Behavioral and Experimental Finance, Elsevier, vol. 39(C).
    12. Wang, Lunyi & Wang, Yao & Zhang, Shunming, 2024. "Probability distortion and non-participation," Economics Letters, Elsevier, vol. 244(C).
    13. Yu Gao & Zhenxing Huang & Ning Liu & Jia Yang, 2024. "Are physicians rational under ambiguity?," Journal of Risk and Uncertainty, Springer, vol. 68(2), pages 183-203, April.
    14. Kanin Anantanasuwong & Roy Kouwenberg & Olivia S. Mitchell & Kim Peijnenberg, 2019. "Ambiguity Attitudes about Investments: Evidence from the Field," NBER Working Papers 25561, National Bureau of Economic Research, Inc.
    15. Cathleen Johnson & Aurélien Baillon & Han Bleichrodt & Zhihua Li & Dennie Dolder & Peter P. Wakker, 2021. "Prince: An improved method for measuring incentivized preferences," Journal of Risk and Uncertainty, Springer, vol. 62(1), pages 1-28, February.
    16. Li, Mingzhe, 2025. "A Theory of Portfolio Choice for Heterogeneous Investors," MPRA Paper 126642, University Library of Munich, Germany, revised 29 Oct 2025.
    17. Sun, Yuzhe & Zhang, Shunming, 2023. "Heterogeneity of probability weighting in investment decisions," Economics Letters, Elsevier, vol. 228(C).
    18. Xie, Yuxin & Tang, Ruohua & Pantelous, Athanasios A. & Lu, Xiaomeng, 2024. "Narrow framing and under-diversification: Empirical evidence from Chinese households," China Economic Review, Elsevier, vol. 83(C).
    19. Richard Gonzalez & George Wu, 2022. "Composition rules in original and cumulative prospect theory," Theory and Decision, Springer, vol. 92(3), pages 647-675, April.
    20. Jeongseop Song & Kim Hiang Liow, 2023. "Industrial tail exposure risk and asset price: Evidence from US REITs," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 51(5), pages 1209-1245, September.
    21. Nicole Hentschel, 2025. "Risk Attitudes do not explain Cash Holdings," Working Papers 25.04, Swiss National Bank, Study Center Gerzensee.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • C83 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - Survey Methods; Sampling Methods
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General

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