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Solutions to the Asset Allocation Problem by Informed Respondents: The Significance of the Size-of-Bet and the 1/N Heuristic

Authors

  • Gordon L. Clark,

    1. Gordon L. Clark is with the Centre for the Environment, Oxford University, South Parks Road, Oxford OX1304, United Kingdom; phone: +44-1865-285197; fax: +44-1865-285073; e-mail: gordon.clark@ouce.ox.ac.uk. Emiko Caerlewy-Smith is with the Centre for the Environment, Oxford University, South Parks Road, Oxford OX1 3QY, United Kingdom; phone: +44-(0)20-7213-8950; fax: +44-(0)20-7212-4418; e-mail: emiko.caerlewy-smith@ouce.ox.ac.uk. John C. Marshall (deceased) was with the Department of Clinical Neurology, John Radcliffe Hospital, Oxford University, Oxford OX3 9DU, United Kingdom. Support for this article was provided by the National Association of Pension Funds (NAPF). The authors thank Christine Farnish, David Gould, and Geoff Lindey for their interest in the project. Helpful comments on the project and related papers have been made by Keith Ambachtsheer, John Evans, Simon Ford, Michael Orszag, Roger Urwin, members of the NAPF Benefits and Investments Councils, participants at the NAPF Investment Conference, the FT-NAPF Trustee Conference, the annual pensions conference at the University of New South Wales (Sydney), and the ICPM Rotman School conference at the University of Toronto. Our thanks go to Amy Dickman who provided assistance in the initial coding and analysis of the data and to Janelle Knox, Esther Lim, Kendra Strauss, and two anonymous referees who commented on previous versions of the article. The first-named author benefited from conversations on the topic with Ashby Monk and Richard Zeckhauser and the exchange of research with Anup Basu, Michael Drew, and Gur Huberman. The results and interpretations reported are the sole responsibility of the authors; none of the above should be held to account for any errors, omissions, or opinions expressed herein. This article was subject to double-blind peer review.
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  • Emiko Caerlewy-Smith,

    1. Gordon L. Clark is with the Centre for the Environment, Oxford University, South Parks Road, Oxford OX1304, United Kingdom; phone: +44-1865-285197; fax: +44-1865-285073; e-mail: gordon.clark@ouce.ox.ac.uk. Emiko Caerlewy-Smith is with the Centre for the Environment, Oxford University, South Parks Road, Oxford OX1 3QY, United Kingdom; phone: +44-(0)20-7213-8950; fax: +44-(0)20-7212-4418; e-mail: emiko.caerlewy-smith@ouce.ox.ac.uk. John C. Marshall (deceased) was with the Department of Clinical Neurology, John Radcliffe Hospital, Oxford University, Oxford OX3 9DU, United Kingdom. Support for this article was provided by the National Association of Pension Funds (NAPF). The authors thank Christine Farnish, David Gould, and Geoff Lindey for their interest in the project. Helpful comments on the project and related papers have been made by Keith Ambachtsheer, John Evans, Simon Ford, Michael Orszag, Roger Urwin, members of the NAPF Benefits and Investments Councils, participants at the NAPF Investment Conference, the FT-NAPF Trustee Conference, the annual pensions conference at the University of New South Wales (Sydney), and the ICPM Rotman School conference at the University of Toronto. Our thanks go to Amy Dickman who provided assistance in the initial coding and analysis of the data and to Janelle Knox, Esther Lim, Kendra Strauss, and two anonymous referees who commented on previous versions of the article. The first-named author benefited from conversations on the topic with Ashby Monk and Richard Zeckhauser and the exchange of research with Anup Basu, Michael Drew, and Gur Huberman. The results and interpretations reported are the sole responsibility of the authors; none of the above should be held to account for any errors, omissions, or opinions expressed herein. This article was subject to double-blind peer review.
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  • John C. Marshall

    1. Gordon L. Clark is with the Centre for the Environment, Oxford University, South Parks Road, Oxford OX1304, United Kingdom; phone: +44-1865-285197; fax: +44-1865-285073; e-mail: gordon.clark@ouce.ox.ac.uk. Emiko Caerlewy-Smith is with the Centre for the Environment, Oxford University, South Parks Road, Oxford OX1 3QY, United Kingdom; phone: +44-(0)20-7213-8950; fax: +44-(0)20-7212-4418; e-mail: emiko.caerlewy-smith@ouce.ox.ac.uk. John C. Marshall (deceased) was with the Department of Clinical Neurology, John Radcliffe Hospital, Oxford University, Oxford OX3 9DU, United Kingdom. Support for this article was provided by the National Association of Pension Funds (NAPF). The authors thank Christine Farnish, David Gould, and Geoff Lindey for their interest in the project. Helpful comments on the project and related papers have been made by Keith Ambachtsheer, John Evans, Simon Ford, Michael Orszag, Roger Urwin, members of the NAPF Benefits and Investments Councils, participants at the NAPF Investment Conference, the FT-NAPF Trustee Conference, the annual pensions conference at the University of New South Wales (Sydney), and the ICPM Rotman School conference at the University of Toronto. Our thanks go to Amy Dickman who provided assistance in the initial coding and analysis of the data and to Janelle Knox, Esther Lim, Kendra Strauss, and two anonymous referees who commented on previous versions of the article. The first-named author benefited from conversations on the topic with Ashby Monk and Richard Zeckhauser and the exchange of research with Anup Basu, Michael Drew, and Gur Huberman. The results and interpretations reported are the sole responsibility of the authors; none of the above should be held to account for any errors, omissions, or opinions expressed herein. This article was subject to double-blind peer review.
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Abstract

Asset allocation is a classic topic in the theory of finance and a crucial issue for investment policy. Noted for its significance in driving pension fund performance, it is also an issue that individual investors consider when designing their investment portfolios. In theory, Markowitz and those following in his wake have an optimal solution. In practice, however, we show that when asked to allocate their own money to a set of asset classes (from relatively low risk to high risk) in an experimental situation, most of our informed respondents would vary their investment strategies according to the size-of-bet (the money value of assets to be invested). We also show that most participants in the study adopted one of three solutions to the posed problem only one of which could be thought consistent with Benartzi and Thaler's 1/n heuristic. Since respondent solutions do not seem to be explained by formal education, professional qualifications, or training, it is suggested that solutions to the asset allocation problem are a product of strategies that mix intuitive responses to the initial tranche of money with theoretical cum practical shared conventions. Solutions to the asset allocation puzzle suggest that the size-of-bet could be a significant consideration for many informed investors. In conclusion, suggestions are made about taking forward closer scrutiny of these experimental results.

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