Irrational diversification: An examination of individual portfolio choice

Guido Baltussen; Gerrit T. Post

doi:10.1017/S002210901100041X

Irrational diversification: An examination of individual portfolio choice

Guido Baltussen
, Gerrit T. Post

Research output: Contribution to journal › Article › peer-review

36 Citations (Scopus)

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.

Original language	English
Pages (from-to)	1463-1491
Number of pages	29
Journal	Journal of Financial and Quantitative Analysis
Volume	46
Issue number	5
DOIs	https://doi.org/10.1017/S002210901100041X
Publication status	Published - Oct 2011
Externally published	Yes

Funding

∗Baltussen, [email protected], Erasmus School of Economics, Burgemeester Oudlaan 50, Rotterdam 3000 DR, The Netherlands, and New York University; Post, [email protected], Graduate School of Business, Koc¸ University, Rumelifeneri Yolu, Istanbul 34450, Turkey. Financial support by Tinbergen Institute, Erasmus Research Institute of Management, Erasmus Center of Financial Research, Erasmus Trustfonds, ING Investment Management, and Robeco Asset Management is gratefully acknowledged. We thank Elena Asparouhova (the referee), Shlomo Benartzi, Hendrik Bessembinder (the editor), Werner De Bondt, Haim Levy, Kasper Meisner Nielsen, Jaap Spronk, Philippe Versijp, Pim van Vliet, and seminar participants at the 2008 Behavioral Decision Research in Management (BDRM) conference in San Diego, the 2010 Financial Management Association (FMA) meeting in New York, the Erasmus School of Economics, University of Amsterdam, and Tinbergen Institute for very helpful comments and discussions. Any remaining errors are the authors’ responsibility.

ASJC Scopus subject areas

Accounting
Finance
Economics and Econometrics

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Cite this

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title = "Irrational diversification: An examination of individual portfolio choice",

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.",

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Irrational diversification: An examination of individual portfolio choice

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