Stefan Zeisberger

Improving Investment Decisions with Simulated Experience

We apply a new and innovative approach to communicating risks associated with financial products that should support investors in making better investment decisions. In our experiments, participants are able to gain “simulated experience” by random sampling of a previously described return distribution. We find that simulated experience considerably improves participants’ understanding of the underlying risk-return profile and prompts them to reconsider their investment decisions and to choose riskier financial products without regretting their higher risk-taking behavior afterwards. This method of experienced-based learning has high potential for being integrated into real-world applications and services.

All’s Well That Ends Well? On the Importance of how Returns are Achieved

We demonstrate that investor satisfaction and investment behavior are influenced substantially by the price path by which the final investor return is achieved. In a series of experiments, we analyze various different price paths. Investors are most satisfied if their assets first fall in value and then recover, and they are least satisfied with the opposite pattern, independent of whether the final return is positive or negative. Price paths systematically influence risk preferences, return beliefs, and ultimately trading decisions. Our results enable a much more holistic perspective on a wide range of topics in finance, such as the disposition effect, risk-taking behavior after previous gains and losses, and behavioral asset pricing.

How Risk Simulations Improve Long-Term Investment Decisions

Investor behavior was shown to be considerably different when the risk-return tradeoff is presented by experience sampling as opposed to a descriptive communication. We analyze the persistency of this difference in a setting in which investors are faced with multiple decisions over time and are consequently able to adjust the risk level they initially chose. For this we use an experimental setting with repeated investment decisions over multiple trading days, and we also test a new form of risk simulation in which wealth paths over time are presented rather than just final outcomes. After investors’ initial decisions, for which we confirm previous findings, we do not find persistent differences of simulation-based learning on investors’ risk-taking behavior. With regards to trading volume, only a simulation in which investors see wealth paths and not only final outcomes leads to lower trading frequency soon after the initial asset allocation.Risk simulations, which dynamically demonstrate investors the possible consequences of their investment decisions, were shown to play an integral part in comprehending the riskreturn trade-off and improving investment decision making. Up to now, studies have taken a static, short-term perspective focusing on just the initial investment decision. We analyze the benefits of risk simulations in a long-term experiment in which investors experience intermediate investment success and can adjust their investment strategy along the way. We find results underscoring the positive effects of risk simulations on investors’ understanding of the risk-return trade-off. Also, investors who do not use simulations need multiple investment periods until they show stable average risk taking behavior. JEL Classification: D81; G11

Do People Care About Loss Probabilities

In a series of experiments we demonstrate that people pay explicit attention to the probability of losing. Participants’ willingness to take risks and choice behavior is considerably influenced by loss probabilities, and performance feedback seems unable to mitigate this effect. This behavior contradicts predictions of normative and descriptive decision theories such as Expected Utility Theory and (Cumulative) Prospect Theory for typically assumed preference parameters and functional forms. Our results hold for investment, allocation and choice tasks, for repeated decisions and one-shot ones as well as for decision from experience and decisions based on description.

How Persistent are the Effects of Experience Sampling on Investor Behavior

Investor behavior was shown to be considerably different when the risk-return tradeoff is presented by experience sampling as opposed to a descriptive communication. We analyze the persistency of this difference in a setting in which investors are faced with multiple decisions over time and are consequently able to adjust the risk level they initially chose. For this we use an experimental setting with repeated investment decisions over multiple trading days, and we also test a new form of risk simulation in which wealth paths over time are presented rather than just final outcomes. After investors’ initial decisions, for which we confirm previous findings, we do not find persistent differences of simulation-based learning on investors’ risk-taking behavior. With regards to trading volume, only a simulation in which investors see wealth paths and not only final outcomes leads to lower trading frequency soon after the initial asset allocation.Risk simulations, which dynamically demonstrate investors the possible consequences of their investment decisions, were shown to play an integral part in comprehending the riskreturn trade-off and improving investment decision making. Up to now, studies have taken a static, short-term perspective focusing on just the initial investment decision. We analyze the benefits of risk simulations in a long-term experiment in which investors experience intermediate investment success and can adjust their investment strategy along the way. We find results underscoring the positive effects of risk simulations on investors’ understanding of the risk-return trade-off. Also, investors who do not use simulations need multiple investment periods until they show stable average risk taking behavior. JEL Classification: D81; G11

How Investment Performance Affects the Formation and Use of Beliefs

We provide evidence that people do not consistently incorporate their beliefs into investment decisions. Our experimental findings indicate that selling is considerably less belief-driven than buying. This difference stems from selling decisions in the presence of paper losses for which we observe that the belief sensitivity is reduced by half. Selling decisions for paper gains, however, are as sensitive to beliefs as buying decisions. The lower belief sensitivity for selling decisions holds also in settings where investors’ accounts are neutralized in each period, albeit with a lower magnitude. While buying decisions increase investors’ wealth we find selling decisions to have a negative effect.

Does Investor Risk Perception Drive Asset Prices in Markets? Experimental Evidence

We explore how individual risk perception influences prices and trading behavior in a market setting. Specifically, our study lets experimental participants trade assets characterized by varying shapes of return distributions. While common mean-variance models predict identical prices for most of our assets, we find trading prices to differ significantly. Assets that are perceived as being less risky on average (despite having identical volatility) trade at significantly higher prices. Individually, traders who perceive a certain asset to be less risky are also net buyers on average. With regard to different risk measures, our results show that the probability of a loss is the strongest predictor of transaction prices and risk perception. All these results hold also for experienced traders and when traders can trade two assets at the same time.

Do Risk Simulations Lead to Persistently Better Investment Decisions

Investor behavior was shown to be considerably different when the risk-return tradeoff is presented by experience sampling as opposed to a descriptive communication. We analyze the persistency of this difference in a setting in which investors are faced with multiple decisions over time and are consequently able to adjust the risk level they initially chose. For this we use an experimental setting with repeated investment decisions over multiple trading days, and we also test a new form of risk simulation in which wealth paths over time are presented rather than just final outcomes. After investors’ initial decisions, for which we confirm previous findings, we do not find persistent differences of simulation-based learning on investors’ risk-taking behavior. With regards to trading volume, only a simulation in which investors see wealth paths and not only final outcomes leads to lower trading frequency soon after the initial asset allocation.Risk simulations, which dynamically demonstrate investors the possible consequences of their investment decisions, were shown to play an integral part in comprehending the riskreturn trade-off and improving investment decision making. Up to now, studies have taken a static, short-term perspective focusing on just the initial investment decision. We analyze the benefits of risk simulations in a long-term experiment in which investors experience intermediate investment success and can adjust their investment strategy along the way. We find results underscoring the positive effects of risk simulations on investors’ understanding of the risk-return trade-off. Also, investors who do not use simulations need multiple investment periods until they show stable average risk taking behavior. JEL Classification: D81; G11