Domain-dependent Diversification: The Influence of Gain-loss Domain and Information Aggregation on Correlation Choice
43 Pages Posted: 27 Aug 2021
Date Written: August 5, 2021
Despite the compelling evidence on gain-loss-domain-dependent behavior, research on domain-dependent portfolio diversification is scarce. In an online experimental study, we recruited 251 experienced US retail investors to select portfolios that differ in asset correlation and risk measures in both the gain and the loss domain. Our findings unveil that diversification behavior is domain-dependent and interacts with the level of information aggregation. Presenting aggregated portfolio outcomes prompts portfolio choices consistent with prospect theory risk preferences and generally higher levels of portfolio diversification. In contrast, displaying individual stock outcomes results in more diversified portfolios in the loss compared to the gain domain on average, in line with previous evidence suggesting that individuals do not accurately understand the concept of portfolio diversification.
Keywords: behavioral finance, experimental finance, diversification, domain dependency, asset correlation, counter-cyclical risk aversion, stock market conditions
JEL Classification: D14, D18, G11, G41
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