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Effects of bonuses on diversification in delegated stock portfolio management

Journal article
Authors Martin Hedesström
Maria Andersson
Tommy Gärling
Anders Biel
Published in Journal of Behavioral and Experimental Finance
Volume 7
Issue September
Pages 60-70
ISSN 2214-6350
Publication year 2015
Published at Department of Psychology
Centre for Finance
Pages 60-70
Language en
Keywords Stock portfolio management; Bonus systems; Risk taking
Subject categories Applied Psychology, Economics

Abstract

Our aim is to investigate whether bonuses make stock portfolio managers take higher risks by diversifying less. In two experiments with undergraduates role-playing being professional investors, we test a model implying that they initially anchor on 100% allocation to one of two options delivering the largest bonus payout, then adjust towards allocating equally much to each option (maximal diversification) depending on the degree of perceived uncertainty of the bonus outcome. In Experiment 1 we find as expected that when the bonus is reduced, investment in the preferred option decreases such that diversification increases. Diversification is larger when uncertainty of the bonus outcome is made salient. In Experiment 2weshow that a majority herd strengthens the effect of a bonus for investing in a preferred option despite salient uncertainty of the bonus outcome. In actual stock markets such herding effects would result from investors being similarly rewarded by bonuses.

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