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Title:Correlation neglect in financial decision-making PDF Logo
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:DIW-Diskussionspapiere
Publikationen von Forscherinnen und Forschern des DIW

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