Abstract We study individual portfolio choice in a laboratory experiment and find strong evidence for heuristic behavior. The subjects tend to focus on the marginal distribution of an asset, while largely ignoring its diversification benefits. They follow a conditional 1/ n diversification heuristic as they exclude the assets with an “unattractive” marginal distribution and divide the available funds equally between the remaining “attractive” assets. This strategy is applied even if it leads to allocations that are dominated in terms of first-order stochastic dominance and is clearly irrational. In line with these findings, we find that framing and problem presentation have substantial influence on portfolio decisions.

The value premium is relatively small for investors with a material fixed-income exposure, such as insurance companies and pension funds, especially when they are downside-risk-averse. Value stocks are less attractive to these investors because they offer a relatively poor hedge against poor bond returns. This result arises for plausible, medium-term evaluation horizons of around one year. Our findings cast doubt on the practical relevance of the value premium for these investors and reiterate the importance of the choice of the relevant test portfolio, risk measure and investment horizon in empirical tests of market portfolio efficiency.