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Illusion of Control as a Source of Poor Diversification: Experimental Evidence

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Abstract:

This paper investigates factors that influence individual portfolio allocations, with particular focus on illusion of control. Participants in the experiment form their portfolios of two risky lotteries and one risk-free alternative with the target to reach a predetermined income. Subjects show illusion of control as they excessively invest in a lottery when they are in charge of the chance move. This finding is amplified when self-selection is possible and mitigated when a well-diversified default portfolio is offered. Presenting sequences of chance moves prior to investment does not affect diversification. In line with excessive extrapolation, the higher the number of observed positive prior outcomes, the more likely is a positive prediction and in turn a higher investment.

Keywords: Egocentric biases; Excessive extrapolation; Experimental economics; Illusion of control; Investment decisions; Portfolio selection; Unrealistic optimism

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/15427560902740006

Affiliations: Vienna University of Economics and Business Institute of Economic Policy and Industrial Economics,

Publication date: January 1, 2009

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