Active choice, beliefs updating and subsequent risk taking

Abstract

This paper analyses experimentally whether investors making active choices learn differently from new information than other investors and whether these differences in learning cause differences in the subsequent investment risk taking. The results show that the lack of an active choice reduces the self-serving bias in learning from adverse information. This is evident in the way investors holding risky assets update their beliefs about the prospects of their investments after losses. These investors are more willing to revise their expectations if they did not have actively decided the size of the risk exposure but followed the decision of a manager. The differences in learning from adverse information cause differences in the subsequent risk taking behaviour of risk takers after losses. Eliminating the active choice of risk takers causes an active risk reduction after losses, while a significant part of the effect is caused by difference in the way an active choice affects learning from adverse information. These findings suggest that there is a beliefs channel associated with self serving needs that explain a significant amount of puzzling differences in the trading behaviour of investors with a different involvement in the investment decision process with important implications for personal investment decision behaviour and financial advisors.

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