Hot-Hand Belief and Loss Aversion in Individual Portfolio Decisions: Evidence from a Financial Experiment

We investigate whether the hot-hand belief, typically viewed as a cognitive illusion, endogenously influences portfolio choices in a financial experiment. Participants allocated funds across assets with randomly generated prices, under conditions of known probabilities and varying levels of risk. In a two-stage setup, participants were exposed to random price sequences in the initial stage both to learn about the game and to induce a perception of successful performance streaks. Then, they encountered additional random price paths in the second stage. Our findings show that the hot-hand belief, measured by increased purchases following gains, was effectively induced but did not persist throughout the experiment. Instead, loss aversion prevailed when participants faced sustained negative trends. The study highlights the dynamic interaction between cognitive heuristics and emotional biases, suggesting that belief in trend continuation is shaped by performance feedback but ultimately constrained by the reluctance to realize losses.