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Household portfolio underdiversification and probability weighting : evidence from the field

Author: Stephen G Dimmock; Roy Kouwenberg; Olivia S Mitchell; Kim Peijnenburg; National Bureau of Economic Research,
Publisher: Cambridge, Mass. : National Bureau of Economic Research, 2018.
Series: Working paper series (National Bureau of Economic Research), no. 24928.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
We explore the relation between probability weighting and household portfolio underdiversification in a representative household survey, using custom-designed incentivized lotteries. On average, people display Inverse-S shaped probability weighting, overweighting the small probabilities of tail events. As theory predicts, our Inverse-S measure is positively associated with portfolio underdiversification, which  Read more...
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Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Stephen G Dimmock; Roy Kouwenberg; Olivia S Mitchell; Kim Peijnenburg; National Bureau of Economic Research,
OCLC Number: 1048897294
Notes: "August 2018"
Includes online appendix (19 pages).
Description: 1 online resource (51 pages) : illustrations.
Series Title: Working paper series (National Bureau of Economic Research), no. 24928.
Responsibility: Stephen G. Dimmock, Roy Kouwenberg, Olivia S. Mitchell, Kim Peijnenburg.

Abstract:

We explore the relation between probability weighting and household portfolio underdiversification in a representative household survey, using custom-designed incentivized lotteries. On average, people display Inverse-S shaped probability weighting, overweighting the small probabilities of tail events. As theory predicts, our Inverse-S measure is positively associated with portfolio underdiversification, which results in significant Sharpe ratio losses. We match respondents’ individual stock holdings to CRSP data and find that people with higher Inverse-S tend to pick stocks with positive skewness and hold positively-skewed equity portfolios. We show that these choices reflect preferences rather than probability unsophistication or limited financial knowledge.

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