Risk and uncertainty are not the same thing. Under risk you can put numbers on the odds, and under uncertainty even the odds are unclear. In a representative survey of American households, researchers measured a distaste for unknown odds with questions built on the Ellsberg urn, then set each score against what that household actually held. What did it predict?
It predicted four separate puzzles at once. People more averse to unknown odds were less likely to be in the stock market at all, and held a smaller fraction of their financial assets in equities. They also held fewer foreign stocks, and were likelier to own stock in the company employing them. Among those who did invest, it went with weaker .
Five household portfolio puzzles have resisted tidy explanation for decades: staying out of equities altogether, holding very little in them, favoring domestic stocks, loading up on the employer’s shares, and failing to diversify. They are usually attacked one at a time.
This paper tests whether one preference predicts all five. The authors measured directly, with questions modeled on Ellsberg urns, inside a survey built to represent American households. They then matched the scores to real portfolio composition rather than to stated intentions.
Four of the predictions came out as theory says. Higher aversion went with less market participation, a smaller share of financial assets in stocks and fewer foreign holdings. ran the other way, which fits the reading that an employer registers as known rather than unknown. Conditional on participating, higher aversion went with weaker diversification.
The pattern also showed up in time: during the , the more ambiguity-averse respondents were likelier to sell. None of this proves the preference caused the portfolio, since information, costs, taxes and what a workplace plan offers all point the same way. It does mean the familiar can be bought at the price of diversification, which is the one protection that was nearly free.
wat. When unknown odds repel people, they hold onto the familiar, and the thing they give up is often the spreading of risk itself.
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Familiarity can feel like safety while doing the opposite, since drawing both a salary and a savings balance from one company ties them to a single source of risk.
How do we know?
Dimmock and colleagues measured preferences with custom questions based on Ellsberg urns in a representative US survey, and linked each respondent’s score to the composition of their actual portfolio.
What is still unknown
A survey association does not establish that a psychological preference alone shaped the portfolio. Information, taxes and institutional constraints push in the same directions.
Learn something?
Where to next
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