Investment Behavior Depending on the Availability of Information on Losing Cases: Financial Experiments

The objective of this paper is to study in how the decision making behaviors of investors differ when they receive different types of information about downside risk prior to the decision making process. Classical finance theory agues that an investor decides the asset allocation among risky assets and safer assets based on the expected excess return and investor's risk tolerance. However, recent research indicates that the allocation to risky assets will decrease if an investor is loss averse, that is, if he is more acutely aware of a loss than a gain of equal size. When he learns about the risks of financial products, an attitude of loss averseness may occur, but it is generally difficult to distinguish whether his investment decision is extremely risk averse or loss averse. Because of this, we controlled for the effects of assertion of prevailing finance theory that an investor's asset allocation varies because he has different risk aversion from others, we showed that the investor allocates assets in a loss averse manner in our laboratory room, when explicit downside risk information about his betting is in front of him. We placed subjects in 2*2 groups and compared the results. One subject group had information about the expected value of compensation. The others are shown to the expected value as well as the down side risk information. We recruited two types of subjects. One group was the financial professionals and the other group was typical office workers. Subjects are asked to buy a risky security given a certain budget. Their reward was decided by the payoff of the risky security. The expected compensation is calculated by a concave function of bet units of risky security. If subjects are rational, there should not be any difference of bet units among subject groups. However, we confirmed the existence of a difference. The difference between observed investor's allocation of the risky asset in the presence of down side information and the results of expected utility maximization is statistically significant. The difference in allocation of the risky asset between the typical investors and the professionals is also statistically significant. A typical investor seems to be more loss averse than the professionals. We conjecture that investors may decide their allocation to risky securities, when down side information is explicitly showed to him, by 1) over-estimating the probability of losing and maximizing expected utility based on their perceived probability of losing, or 2) trying to keep certain wealth even when they lose. This study demonstrates how suggestive the inclusion of risk information, especially down side risk information, in a financial product's prospectus is. Therefore, the utmost care should be taken in presenting it.