Eyster, Erik and Weizsacker, Georg (2011) Correlation neglect in financial decision-making. Discussion Papers, 1104. DIW, Berlin, Germany.Full text not available from this repository.
Good decision-making often requires people to perceive and handle a myriad of statistical correlations. Notably, optimal portfolio theory depends upon a sophisticated understanding of the correlation among financial assets. In this paper, we examine people's understanding of correlation using a sequence of portfolio-allocation problems and find it to be strongly imperfect. Our experiment uses pairs of portfolio-choice problems that have the same asset span|identical sets of attainable returns|and differ only in the assets' correlation. While any outcome-based theory of choice makes the same prediction across paired problems, subjects behave very differently across pairs. We find evidence for correlation neglect|treating correlated variables as uncorrelated|as well as for a form of \1/n heuristic"|investing half of wealth each of the two available assets.
|Item Type:||Monograph (Discussion Paper)|
|Additional Information:||© 2011 DIW|
|Uncontrolled Keywords:||portfolio choice, correlation neglect, 1/n heuristic, biases in beliefs|
|Library of Congress subject classification:||H Social Sciences > HB Economic Theory|
|Journal of Economic Literature Classification System:||B - Schools of Economic Thought and Methodology > B4 - Economic Methodology > B49 - Other|
|Sets:||Departments > Economics
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