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Irrational Diversification: An Examination of Individual Portfolio Choice

Published online by Cambridge University Press:  06 June 2011

Guido Baltussen  and
Gerrit T. Post
Guido Baltussen
Affiliation:
Erasmus School of Economics, Burgemeester Oudlaan 50, Rotterdam 3000 DR, The Netherlands, and New York University, guidobaltussen@gmail.com
Gerrit T. Post
Affiliation:
Graduate School of Business, Koç University, Rumelifeneri Yolu, Istanbul 34450, Turkey, thierrypost@hotmail.com
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Abstract

We study individual portfolio choice in a laboratory experiment and find strong evidence for heuristic behavior. The subjects tend to focus on the marginal distribution of an asset, while largely ignoring its diversification benefits. They follow a conditional 1/n diversification heuristic as they exclude the assets with an “unattractive” marginal distribution and divide the available funds equally between the remaining “attractive” assets. This strategy is applied even if it leads to allocations that are dominated in terms of first-order stochastic dominance and is clearly irrational. In line with these findings, we find that framing and problem presentation have substantial influence on portfolio decisions.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 5 , October 2011 , pp. 1463 - 1491
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

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