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Hidden skewness: On the difficulty of multiplicative compounding under random shocks

Author

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  • Zankiewicz, Christian
  • Ensthaler, Ludwig
  • Nottmeyer, Olga
  • Weizsäcker, Georg

Abstract

Multiplicative growth processes that are subject to random shocks often have an asymmetric distribution of outcomes. In a series of incentivized laboratory experiments we show that a large majority of participants either strongly underestimate the asymmetry or ignore it completely. Participants misperceive the outcome distribution's spread to be too narrow-band and they estimate the median and the mode to lie too close to the distribution's center. The observed bias in expectations is irrespective to risk preferences and it appears under a variety of conditions regarding feedback, incentive size, and market contexts. The bias is largely consistent with a behavioral model in which geometric growth is confused with linear growth. This misperception is a possible explanation of investors' difficulties with real-world financial products like leveraged ETFs and is also related to issues regarding real estate investments, retirement savings plans or investments in college funds.

Suggested Citation

  • Zankiewicz, Christian & Ensthaler, Ludwig & Nottmeyer, Olga & Weizsäcker, Georg, 2015. "Hidden skewness: On the difficulty of multiplicative compounding under random shocks," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 112815, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc15:112815
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    References listed on IDEAS

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    1. Ludwig Ensthaler & Olga Nottmeyer & Georg Weizsäcker & Christian Zankiewicz, 2013. "Hidden Skewness: On the Difficulty of Multiplicative Compounding under Random Shocks," Discussion Papers of DIW Berlin 1337, DIW Berlin, German Institute for Economic Research.
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    Cited by:

    1. Ludwig Ensthaler & Olga Nottmeyer & Georg Weizsäcker & Christian Zankiewicz, 2013. "Hidden Skewness: On the Difficulty of Multiplicative Compounding under Random Shocks," Discussion Papers of DIW Berlin 1337, DIW Berlin, German Institute for Economic Research.
    2. Matthew R Levy & Joshua Tasoff, 2016. "Misunderestimation: exponential-growth bias and time-varying returns," Economics Bulletin, AccessEcon, vol. 36(1), pages 29-34.

    More about this item

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance

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