How to Alleviate Correlation Neglect in Investment Decisions

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...

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Bibliographic Details
Published in:Management science 2023-06, Vol.69 (6), p.3400-3414
Main Authors: Laudenbach, Christine, Ungeheuer, Michael, Weber, Martin
Format: Article
Language:English
Subjects:
Alleviation
Assets
correlation neglect
Diversification
Experiments
FinTech
investment decisions
Investors
Management science
Probability
risk taking
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Summary: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). This paper was accepted by Manel Baucells, behavioral economics and decision analysis. Funding: This work was supported by the Academy of Finland [Decision Item 322357] and the Deutsche Forschungsgemeinschaft [Grant We993/15-1]. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4535 .
ISSN:0025-1909
1526-5501
DOI:10.1287/mnsc.2022.4535