A team of economists at MIT and Harvard University gave subjects a choice: to invest in a safe asset at 5 per cent interest rate, or in a risky asset with an expected return of 10 per cent and standard deviation of 18 percentage points. On average, subjects put 66.8 per cent of their money into the risky asset. Then they offered a different choice: between a safe asset paying 1 per cent, and a risky one offering a 6 per cent expected return with a standard deviation of 18 percentage points. The weighting in the risky asset then rose to 75.6 per cent, a jump of 8.8 percentage points.
From the point of view of standard economics, this makes no sense. The risk premium didn't change: it was five percentage points in both cases. Nor did risk. Conventional portfolio theory thus says asset allocation shouldn't change. But it did. And the people who changed it weren't fools from off the street: they were MBA students at Harvard Business School, one of the most prestigious courses in the world.