Citation

Discussion Paper Details

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Title: Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

Author(s): Steve Dimmock, Roy Kouwenberg, Olivia S Mitchell and Kim Peijnenburg

Publication Date: August 2018

Keyword(s): cumulative prospect theory, household finance, household portfolio puzzles, portfolio underdiversification, probability weighting, rank dependent utility and Stock Market Participation

Programme Area(s): Financial Economics

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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Bibliographic Reference

Dimmock, S, Kouwenberg, R, Mitchell, O and Peijnenburg, K. 2018. 'Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13109