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Abstract: Inadequate consideration of inflation when making long-term financial decisions – so-called money illusion – can have severe consequences for future financial wellbeing. Thus, it is essential to understand how different methods of informing private investors about inflation affect their investment decisions. We propose a novel mechanism for experimental remuneration that can be used to systematically explore money illusion and its consequences. The mechanism imitates the disparity between nominal wealth and real purchasing power by a declining conversation rate. We demonstrate the flexibility and virtues of the new approach through two experimental studies. The objective of the first study is to generate a calibrated measure of money illusion that can be incorporated directly into economic modeling. Meanwhile, the second study is designed to generally explore how behavior in informational settings that are more or less susceptible to money illusion deviates from an unaffected preference benchmark. We find a substantial degree of money illusion in Study 1 and document nuanced behavioral patterns, including meta-cognitive components, in Study 2. (SSRN)
Online platforms have made financial investing easier and more accessible than ever before, but little is known about how the choice architecture of these platforms— both in terms of how information is presented and how preferences are elicited— influences investment allocation decisions. Past research has shown that many people tend to “naïvely diversify” their investment funds, allocating 1/n of the total to each of n available instruments. The current work presents new experimental evidence that choice architecture can bias decisions among naively diversifying investors in three distinct ways. We first demonstrate partition-dependence, in which investor allocations vary systematically with the arbitrary grouping of investment options (by vendor and instrument). We next demonstrate unit-dependence, in which investor allocations vary systematically with the units in which the investment quantity is specified (numbers of shares purchased versus dollars invested). Finally, we demonstrate procedure-dependence, in which investment allocations vary systematically with the way in which preferences are elicited (choosing versus allocating). We observe these results among sophisticated participants, using both naturalistic investments and simple well-specified lotteries with incentive-compatible payoffs. We close with a discussion of implications for improving the design of asset allocation procedures.