Complexity and Sophistication
Many financial situations present individuals with simple alternatives to solving complex problems. Are individuals sophisticated; do they know when they are better off opting out of complexity? We tested complexity's effects and evaluated sophistication in a large and diverse sample. We randomly assigned both complexity to portfolio problems and the offer of a simple alternative to portfolio choice. The less skilled opt out more often under complexity and thus earn lower returns, often from dominated choices. Estimated with a novel identification strategy, the structural parameters of a rational inattention model are, nevertheless, consistent with substantial sophistication. Substantial fractions of the money lost by opting out can be justified by attention cost savings.
This paper benefited from many discussions with Shachar Kariv, and participants in several seminars and conferences. Special thanks to Alisdair McKay, Andrew Caplin, Juan Carillo, Mark Dean, Alex Rees-Jones, John Leahy, and Jeremy Tobacman for their thoughtful comments, and to Carla Blair, Tania Gutsche, Adrian Montero, Bart Oriens, and Bas Weerman for their integral work on implementing the experiment. Francesco Agostinelli provided exemplary research assistance. This work was funded by the National Institute on Aging (NIA P30AG024962) through USC's Roybal Center for Financial Decision Making. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.