Why Do Investors Buy Bad Financial Products? Probability Misestimation and Preferences in Financial Investment Decision

Abstract

We study the influence of systematic probability misestimation on complex financial investment decisions on the context of structured financial products. Structured products have become more and more complex. We study the question whether this complexity might be a sophisticated method to exploit systematic biases in probability estimation of investors in order to make products look safer and more attractive than they actually are. We present results of an experiment that focused on probability estimates in the context of certain classes of structured products, in particular barrier reverse convertibles, bonus certificates, and worst-of basket certificates. We find that behavioral biases, for example, the conjunction fallacy, increase the subjective attractiveness of these product types. We also investigate potential ways to de-bias investors by providing additional information.

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