Portfolio Choice and Risk Attitudes: An Experiment

35 Pages Posted: 22 Apr 2003

See all articles by Gary Charness

Gary Charness

University of California, Santa Barbara (UCSB) - Department of Economics

Uri Gneezy

University of California, San Diego (UCSD) - Rady School of Management

Date Written: February 20, 2003

Abstract

We study the following basic intuition: when faced with a decision how to split their investment between a risky lottery and an asset with a fixed return, people increase the proportion invested in the risky option the more they like the lottery. We find counter-examples to this, and in fact we find no simple relation between preferences between lotteries and the fraction invested in them. We use three well-documented biases (ambiguity aversion, the illusion of control and myopic loss aversion) to show this. First we replicate the previous results in a laboratory experiment with financial incentives, and then test whether participants are willing to explicitly pay a small sum of money in line with the bias (pay for less ambiguity, more perceived control, or more frequent information about portfolio performance). We then study how portfolio choice depends on these biases.

With the parameters chosen, the illusion of control was eliminated when participants were asked to pay to gain more control, and the bias did not affect investment behavior (i.e., participants invested in a risky option the same fraction when faced with more or less control). In the ambiguity treatment, people were willing to pay for less ambiguity, but again the level of ambiguity did not influence investment. Finally, in the myopic loss aversion treatment participants were willing to pay money to have more freedom to choose, even though (in line with the documented bias) they invested less when having more freedom to change their investment.

Keywords: Ambiguity aversion, behavioral finance, illusion of control, lotteries, myopic loss aversion, portfolio choice, risk attitudes

JEL Classification: B49, C91, D81, G11, G19

Suggested Citation

Charness, Gary and Gneezy, Uri, Portfolio Choice and Risk Attitudes: An Experiment (February 20, 2003). Available at SSRN: https://ssrn.com/abstract=397300 or http://dx.doi.org/10.2139/ssrn.397300

Gary Charness (Contact Author)

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States
805-893-2412 (Phone)
805-893-8830 (Fax)

Uri Gneezy

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
1,038
Abstract Views
6,780
Rank
39,808
PlumX Metrics