Biases in allocation under risk and uncertainty: Partition dependence, unit dependence, and procedure dependence

Previous studies of employee investment in retirement plans suggest that people typically "naively diversify" their investment funds, tending to allocate 1/n of the total to each of n available instruments (Benartzi & Thaler, 2001). In this paper we provide experimental evidence that this bias extends to allocation among simple chance prospects and demonstrate three new violations of rational choice theory implied by use of the naïve diversification strategy. Study 1 demonstrates “partition dependence” in which participants' allocations among a fixed set of investments varies with the hierarchical structure of the option set (e.g., by vendor and instrument). Study 2 demonstrates “unit dependence” in which participants' preferred allocations vary with the metric in which the investment is reported (dollars versus number of shares). Study 3 demonstrates “procedure dependence” in which the bias toward even allocation disappears if participants are asked to choose from a menu of possible portfolios. We show that these results extend to sophisticated participants, simple well-specified gambles and incentivecompatible payoffs. We close with a discussion of theoretical and prescriptive implications.