Behavioral Factors in Equity Allocation Decisions: A Large-Scale Experimental Study With Context

Abstract

ABSTRACTTraditional models of rational behavior struggle to explain how individuals allocate their money over a variety of financial instruments, including annuities, the stock market, and risk-free bonds. This study uses a large and diverse data set from an investment experiment that is rich in context and captures some important features of actual financial decision making. The focus of the article is to build on the literature documenting behavioral explanations for investment choices by studying the equity allocation decision across different financial tools. The authors find evidence that risk aversion, inertia, and excessive extrapolation are associated with investment behavior even when it is clear that return rates are independent across decision-making periods. Further, subjects have an asymmetric response to positive versus negative returns. In addition to having a novel experimental design, the authors also examine behavior before and after the recent financial crisis. The authors find that the financial crisis indirectly affects the first-stage annuity take-up rate in the experiments vis-à-vis a higher average level of risk aversion after the start of the crisis.