Federico Guerrero

Managing a 401(k) Account: An Experiment on Asset Allocation

This paper reports the results of a behavioral finance experiment on asset allocation. Subjects managed a portfolio and made repeated asset allocations to stocks, bonds, and cash. The task was designed to be similar to what a typical investor would face in managing a 401(k) account for twenty years. The primary manipulation in the experiment was the introduction of portfolio future value projections. The results indicate that subjects who receive future value projections create portfolios with higher allocations to stocks and higher portfolio expected return, and allocations to stocks tends to increase with age. In the aggregate subjects do reasonably well in creating efficient portfolios. The results have implications for reducing myopic loss aversion and for the efficient financial engineering of defined contribution accounts.

The effect of setting goals and emotions on asset allocation decisions

Purpose - The purpose of this paper is to conduct a controlled experiment to examine the effect of goal setting and affect framed feedback on repeated asset allocation investment decisions. Design/methodology/approach - The design of the experiment is a 2×2 between subject design. Subjects allocated monies among four investments for 20 periods. One manipulation varied whether subjects received performance feedback in the form of a happy or sad face, while another manipulation varied whether subjects set a financial goal for themselves and received goal attainment performance feedback. Findings - The main findings include: subjects initially allocate assets in a manner roughly consistent with their stated preference for risk; prior year asset performance leads subjects to make significant changes in portfolio asset allocation in a manner consistent with beliefs of positive autocorrelation in asset returns; and the addition of happy or sad faces to performance feedback information leads to even greater changes in asset allocation. Originality/value - Using ideas from the theory on the self-regulation of behavior and the role of affect in decision making, the authors develop an original framework to account for the results.

Does Experiencing a Crash Make All the Difference? An Experiment on the Depression Babies Hypothesis

Do people who lived through the depression take fewer financial risks because of the negative returns experienced? More generally, what is the importance of historical return streams on current investment decisions? This experiment tests this experience hypothesis and finds that subjects who experience a great crash hold, on average, 6% less of their assets in stocks than subjects who did not experience the crash, after controlling for gender, employment status, and financial literacy. Our results suggest that subjects who experience a significant market crash have lower and more volatile beliefs regarding future stock returns. Furthermore, we find that experiencing a crash causes a significant difference in the overall belief distributions between the two groups, with the crash cohort holding more realistic beliefs about future stock market returns.

Gain attraction in the presence of social interactions

Purpose The purpose of this paper is to suggest that a fundamental cause of market booms and busts is that investor risk attitudes change during market booms. Specifically, the authors propose that an investor’s risk aversion falls as (s)he attempts to “keep up with the Joneses.” This paper studies changing risk attitudes induced by social interactions, and shows that risk-seeking behavior that is initially successful may induce copycat behavior and lead individuals in the same peer group to reduce their degree of risk aversion to attempt to obtain similar rewards, a phenomenon we call “Gain attraction in the presence of social interactions.” Design/methodology/approach The authors propose a new theoretical model that incorporates the social interaction term into the value function of prospect theory. The modified value function empowers the standard prospect theory by introducing the idea that people often compare themselves to others and then compare their gains to the gains of others. The model predicts that, if people exhibit some degree of envy, they will treat the observed utility achieved by others as destination points and will reposition themselves to the new reference points, and at that point their willingness to accept risk dramatically increases. Findings The theoretical model is tested empirically against experimental data and survey data. Consistent with the theoretical prediction, the experimental results suggest that, after subjects observed the behavior of the leading investor in the controlled laboratory condition, there was a significant increase in risk-taking behavior. The survey results further confirm that envy is an emotional force behind the dissatisfaction and disappointment among investors when they miss available opportunities that others were able to take advantage of. Originality/value This study provides evidence that investment decisions are not made in a social vacuum by isolated individuals, but rather in social settings in which individuals are influenced by the actions and outcomes of their peers. The study also opens up a new research avenue that the reduction in risk aversion induced by peer effects may be an important element explaining how greed is transmitted across the economy during times of financial boom, thus helping to fuel the flames of financial crises.

How important are early investment experiences on subsequent investment decisions? A laboratory experiment on asset allocation

Purpose - – The purpose of this paper is to examine the influence of early investment experiences on subsequent portfolio allocation decisions in a laboratory setting. Design/methodology/approach - – In an experiment in which the task consisted of allocating a portfolio between a risky and riskless asset for 20 periods, two groups of subjects were confronted with either a market boom or bust in the initial four periods. Findings - – The findings suggest that after controlling for demographic characteristics, the timing of a boom or bust during the investment lifecycle matters greatly. Subjects that faced a bust early in their investment lifecycle held less of the risky asset in subsequent periods compared to subjects who experienced an early boom. Originality/value - – To the best of the authors knowledge this is the first laboratory study investigating the role of early aggregate shocks on subsequent investment behavior.