DP15116 Investor Sophistication and Portfolio Dynamics
|Author(s):||Adrian Buss, Raman Uppal, Grigory Vilkov|
|Publication Date:||July 2020|
|Keyword(s):||Belief formation, household finance, investors' expectations, trend chasing, Wealth Inequality|
|JEL(s):||D53, G11, G51, G53|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=15116|
We develop a dynamic general-equilibrium framework with multiple households and multiple risky assets to explain how less- and more-sophisticated households differ in their portfolio and wealth dynamics. Differences in sophistication are modeled via heterogeneous confidence about asset returns, coupled with Bayesian learning. Consistent with recent empirical evidence, less-sophisticated households overinvest in safe assets, hold underdiversified portfolios concentrated in familiar assets, are trend chasers, and earn lower absolute and risk-adjusted investment returns. Notably, this behavior is a consequence of optimal choices rather than investment mistakes. The model explains why this behavior, despite learning, persists for long periods, thereby exacerbating wealth inequality.