Complexity and Sophistication

Abstract

Many financial situations present individuals with simple alternatives to solving complex problems. Are individuals sophisticated; do they know when they are better off opting out of complexity? We tested complexity s effects and evaluated sophistication in a large and diverse sample. We randomly assigned both complexity to portfolio problems and the offer of a simple alternative to portfolio choice. The less skilled opt out more often under complexity and thus earn lower returns, often from dominated choices. Estimated with a novel identification strategy, the structural parameters of a rational inattention model are, nevertheless, consistent with substantial sophistication. Substantial fractions of the money lost by opting out can be justified by attention cost savings.