Illusion of control as a source of poor diversification: Anexperimental approach

This paper investigates factors influencing individual portfolio allocations withparticular focus on the role of illusion of control. By forming their portfolio of tworisky lotteries and one risk-less alternative, subjects are requested to reach a targetinvestment profit, whereby equal diversification between the two risky lotteriesis part of the solution space. Subjects however excessively invest in the lotteryfor which they can determine the outcome by rolling the die themselves indicatingthat they are prone to illusion of control. However, the effect vanishes withexperience. In contrast, presenting random sequences of prior outcomes reducesbiased investments. In line with the excessive extrapolation hypothesis, the morepositive outcomes observed from past draws, the more likely is a positive predictionfor this lottery, which is then followed by higher investment. Also, offering adefault portfolio strongly determines final allocations.