Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

Stephen Dimmock, Roy Kouwenberg, Olivia Mitchell and Kim Peijnenburg

The Review of Financial Studies, 2021, vol. 34, issue 9, 4524-4563

Abstract: We test whether probability weighting affects household portfolio choice in a representative survey. On average, people display inverse-S-shaped probability weighting, overweighting low probability events. As theory predicts, probability weighting is positively associated with portfolio underdiversification and significant Sharpe ratio losses. Analyzing respondents’ individual stock holdings, we find higher probability weighting is associated with owning lottery-type stocks and positively skewed equity portfolios. People with higher probability weighting are less likely to own mutual funds and more likely to either avoid equities or hold individual stocks. We are the first to empirically link individuals’ elicited probability weighting and real-world decisions under risk.

JEL-codes: C83 D14 D81 D90 G11 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (10)

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Related works:
Working Paper: Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field (2018)
Working Paper: Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field (2018)
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