Fooled By Randomness? Financial Decision-Making Under Model Uncertainty

Posted: 21 Oct 2014 Last revised: 30 Nov 2016

See all articles by Elise Payzan-LeNestour

Elise Payzan-LeNestour

University of New South Wales; Financial Research Network (FIRN)

Date Written: March 22, 2016

Abstract

This study considers model uncertainty about tail risk, the possibility of learning and how this affects choice. I designed an experiment involving repeated risk taking where assets can yield steady streams of good outcomes but eventually inflict a major loss that annihilates all previous gains. Learning about those assets' risk/reward profiles is crucial yet challenging. The main findings are: 1) When asked to perform a stylized version of the task, participants managed to learn in a Bayesian way; 2) However, many still chose to invest in these assets, apparently owing to an overwhelming desire to "pick pennies." These findings suggest that the key issue with tail risk is not the most commonly expected one, namely, that people cannot assess it, but rather that people cannot deal with it due to purely behavioral issues related to limited self-control.

Keywords: Tail Risk, Learning, Self-Control, Negative Skewness, Neurofinance

JEL Classification: C91, D83, D87, G02, G11

Suggested Citation

Payzan-LeNestour, Elise, Fooled By Randomness? Financial Decision-Making Under Model Uncertainty (March 22, 2016). FIRN Research Paper No. 2512185; UNSW Business School Research Paper No. 03. Available at SSRN: https://ssrn.com/abstract=2512185 or http://dx.doi.org/10.2139/ssrn.2512185

Elise Payzan-LeNestour (Contact Author)

University of New South Wales ( email )

Australian School of Business
Sydney, NSW 2052
Australia

HOME PAGE: http://www.elisepayzan.com/

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Register to save articles to
your library

Register

Paper statistics

Abstract Views
2,303
PlumX Metrics