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Investment Talent and the Pareto Wealth Distribution: An Experimental Analysis

  • Author(s): Levy, Shiki
  • Levy, Haim
  • et al.
Abstract

It is a well-documented fact that wealth is distributed according to a power-law (Pareto) distribution at high wealth levels. Various models of wealth accumulation have been suggested in order to explain this empirical wealth distribution. Although these models are quite different one from the other, they are all based on a stochastic multiplicative process, and they all assume homogeneous talent: in these models the only source of inequality is the randomness of the process – luck! These models encounter two serious objections: a) it is claimed that the time it would take a stochastic homogeneous-talent process to generate the Pareto distribution is incredibly long, and b) many consider it unreasonable to assume homogeneous investment talent. Obviously, the provocative idea that inequality is primarily due to change rather than talent has profound political, social, and philosophical implications. In this paper, we hope to shed some light on this controversy with evidence from a unique experiment in which the initial wealth of all participants is equal and real out-of-pocket is involved. We find a convergence of the experimental wealth distribution of the Pareto distribution which is astonishing both in its speed (less than 10 trading sounds), and in its goodness-of-fit ( R^2 > 0.97). Moreover, the Pareto parameter we find is similar in magnitude to the Pareto parameter of the actual wealth distribution in western countries. Analysis of the performance of the 63 participants in the experiment reveals that the differences in terminal wealth are primarily due to chance, rather than talent.

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