Let’s say you have the choice to invest in two portfolios, M and S as described below, which one do you choose?
For a similar value, portfolio S could be the optimal choice because the risks seem to be better distributed between Apple and IBM assets. Then, same question:
Now, is it not portfolio M which appears to be the best choice?
MBA students have been confronted to this choice and most of them did not have the same preference in condition M and S. Two biases are involved in this process.
- Unit dependence bias: Unit dependence bias makes us solve a problem differently according to the units used to present it. Unit dependence bias is a specific case of the framing effect, to be influenced by the way a problem is presented.
- Naive diversification bias: Diversification bias is a kind of heuristic, an intuitive tool to solve rapidly complex problems. This heuristic has been first observed in marketing by Simonson, a psychologist. He showed that when people have to make simultaneous choices (for example, to choose in one shot the portfolio with the best asset allocation), they tend to diversify more of their allocation than when making sequential choices.
For further information about the unit dependence bias:
Biases in allocation under risk and uncertainty: Partition dependence, unit dependence, and procedure dependence Thomas Langer , Fox 2005