Discussion Paper Details

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Title: How to Alleviate Correlation Neglect

Author(s): Christine Laudenbach, Michael Ungeheuer and Martin Weber

Publication Date: May 2019

Keyword(s): Correlation Neglect, Diversification, Fintech, Investment Decisions and Risk Taking

Programme Area(s): Financial Economics

Abstract: We experimentally study how presentation formats for return distributions affect investors' diversification choices. We find that sampling returns alleviates correlationneglect and constitutes an effective way to improve financial decisions. When participants get a description of probabilities for outcomes of the joint return distribution, we confirm the common finding that investors neglect the correlation between assets in their diversification choices. However, when participants sample from the joint distribution, they incorporate correlation into choices as predicted by normative theory. Results are robust across three experiments with varying expertise and experience of participants (students vs. investors), and varying return distributions (discrete, continuous).

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Bibliographic Reference

Laudenbach, C, Ungeheuer, M and Weber, M. 2019. 'How to Alleviate Correlation Neglect'. London, Centre for Economic Policy Research.