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| Title: | | Correlation neglect in financial decision-making  |
| Authors: | | Eyster, Erik Weizsäcker, Georg |
| Issue Date: | | 2011 |
| Series/Report no.: | | Discussion papers // German Institute for Economic Research 1104 |
| Abstract: | | 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. |
| Subjects: | | portfolio choice correlation neglect 1/N heuristic biases in beliefs |
| JEL: | | B49 |
| Document Type: | | Working Paper |
| Appears in Collections: | | Publikationen von Forscherinnen und Forschern des DIW DIW-Diskussionspapiere
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