Perceptions of Epistemic vs. Aleatory Uncertainty Affect Stock Investment

The decision to invest in a stock entails uncertainty. Prior work shows that people intuitively distinguish two independent dimensions of uncertainty: (i) “epistemic” uncertainty that is seen as inherently knowable, given sufficient information; and (ii) “aleatory” uncertainty that is seen as inherently random. We hypothesized that: (1) as investors perceive more epistemic uncertainty in stocks, they will be more sensitive their own level of ignorance, and will manage this uncertainty by seeking expert advice; and (2) as investors perceive more aleatory uncertainty in stocks, they will be more sensitive to their exposure to risk, and will manage this uncertainty by diversifying their portfolios. We tested these predictions using four incentive-compatible lab studies, one survey of self-reported investment behaviors from lay investors, and one survey of practicing financial advisors.