Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

60 Pages Posted: 20 Aug 2018 Last revised: 2 Sep 2020

See all articles by Stephen G. Dimmock

Stephen G. Dimmock

National University of Singapore; Asian Bureau of Finance and Economic Research (ABFER)

Roy Kouwenberg

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Mahidol University - College of Management; Erasmus University Rotterdam (EUR)

Olivia S. Mitchell

University of Pennsylvania - The Wharton School; University of Pennsylvania - The Wharton School, Pension Research Council; National Bureau of Economic Research (NBER)

Kim Peijnenburg

Netspar; Centre for Economic Policy Research (CEPR); EDHEC Business School - Department of Economics & Finance

Multiple version iconThere are 3 versions of this paper

Date Written: August 31, 2020

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.

Keywords: household finance, behavioral economics, probability weighting, rank dependent utility, cumulative prospect theory, salience theory, portfolio underdiversification, household portfolio puzzles

JEL Classification: G11, D81, D14, C83, D90

Suggested Citation

Dimmock, Stephen G. and Kouwenberg, Roy R. P. and Kouwenberg, Roy R. P. and Mitchell, Olivia S. and Peijnenburg, Kim, Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field (August 31, 2020). Wharton Pension Research Council Working Paper No. 2018-09, Available at SSRN: https://ssrn.com/abstract=3228444 or http://dx.doi.org/10.2139/ssrn.3228444

Stephen G. Dimmock (Contact Author)

National University of Singapore ( email )

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Roy R. P. Kouwenberg

Mahidol University - College of Management ( email )

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Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

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Erasmus University Rotterdam (EUR) ( email )

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Olivia S. Mitchell

University of Pennsylvania - The Wharton School ( email )

Philadelphia, PA 19104-6365
United States

University of Pennsylvania - The Wharton School, Pension Research Council ( email )

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National Bureau of Economic Research (NBER)

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Kim Peijnenburg

Netspar ( email )

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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

EDHEC Business School - Department of Economics & Finance ( email )

France

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