Biases in Allocation Under Risk and Uncertainty : Partition Dependence, Unit Dependence, and Procedure Dependence

Previous studies of employee investment in retirement plans suggest that people typically naively diversify their investment funds, tending to allocate 1/n of the total to each of n available instruments (Benartzi amp; Thaler, 2001). In this paper we provide experimental evidence that this bias extends to allocation among simple chance prospects and demonstrate three new violations of rational choice theory implied by use of the naieve diversification strategy. Study 1 demonstrates quot;partition dependencequot; in which participants' allocations among a fixed set of investments varies with the hierarchical structure of the option set (e.g., by vendor and instrument). Study 2 demonstrates quot;unit dependencequot; in which participants' preferred allocations vary with the metric in which the investment is reported (dollars versus number of shares). Study 3 demonstrates quot;procedure dependencequot; in which the bias toward even allocation disappears if participants are asked to choose from a menu of possible portfolios. We show that these results extend to sophisticated participants, simple well-specified gambles and incentive-compatible payoffs. We close with a discussion of theoretical and prescriptive implications