The Neglect of Correlation in Allocation Decisions

36 Pages Posted: 24 May 2018

See all articles by Ido Kallir

Ido Kallir

Ono Academic College

Doron Sonsino

Ben-Gurion University of the Negev; Center for Academic Studies

Date Written: May 13, 2009

Abstract

We study the effect of variation in correlation on investment decision in an experimental two asset application. Comparison of allocations across problems suggests that subjects neglect probabilistic information on the joint distribution of returns and base their allocations on the observed return levels for the two assets. When asked to predict future returns, subjects try to replicate the historical distribution, thereby falling into the probability-matching bias. Predictions drastically vary when correlations become negative, while allocations are not significantly affected by changes in sign of correlation. The observed allocation patterns contradict the predictions of standard models of choice; the inconsistency is attributed to common behavioral bias in financial decision. Field implications of the results are discussed.

JEL Classification: G11 C91 D81

Suggested Citation

Kallir, Ido and Sonsino, Doron, The Neglect of Correlation in Allocation Decisions (May 13, 2009). Southern Economic Journal, Vol. 75, No. 4, 2009. Available at SSRN: https://ssrn.com/abstract=3177729

Ido Kallir (Contact Author)

Ono Academic College ( email )

Tzahal Street 104
Kiryat Ono, 55000
Israel

Doron Sonsino

Ben-Gurion University of the Negev ( email )

1 Ben-Gurion Blvd
Beer-Sheba 84105, 84105
Israel

Center for Academic Studies ( email )

Ha-Yotsrim 2
Or Yehuda, 6021816
Israel

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