Correlation Neglect In Financial Decision-Making

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Executive Summary

Good decision-making often requires people to perceive and handle a myriad of statistical correlations. Notably, optimal portfolio theory depends upon a sophisticated understanding of the correlation among financial assets. In this paper, the authors examine people's understanding of correlation using a sequence of portfolio-allocation problems and find it to be strongly imperfect. This experiment uses pairs of portfolio-choice problems that have the same asset span-identical sets of attainable returns- and differ only in the assets' correlation.

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