Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

Kim Peijnenburg, Stephen Dimmock, Roy Kouwenberg and Olivia Mitchell

No 13109, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Household finance; Portfolio underdiversification; Probability weighting; Rank dependent utility; Cumulative prospect theory; Household portfolio puzzles; Stock market participation (search for similar items in EconPapers)
JEL-codes: C83 D14 D81 G11 (search for similar items in EconPapers)
Date: 2018-08
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (7)

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Related works:
Journal Article: Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field (2021)
Working Paper: Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field (2018)
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