Working Paper: CEPR ID: DP14361
Authors: Felipe Saraiva Iachan; Plamen T. Nenov; Alp Simsek
Abstract: Financial innovation in recent decades has expanded portfolio choice. We investigate how greater choice affects investors' savings and asset returns. We establish a choice channel by which greater portfolio choice increases investors' savings---by enabling them to earn the aggregate risk premium or to take speculative positions. In equilibrium, portfolio customization (access to risky assets beyond the market portfolio) reduces the risk-free rate. Participation (access to the market portfolio) reduces the risk premium but typically increases the risk-free rate. Empirically, stock market participants in the U.S. save more than nonparticipants, and have increasingly dispersed portfolio returns, consistent with the choice channel.
Keywords: belief disagreements; speculation; financial innovation; savings; interest rate; risk premium; customization; participation
JEL Codes: E21; E43; E44; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| greater portfolio choice (G11) | increased savings (D14) |
| greater portfolio choice (G11) | earn the aggregate risk premium (G12) |
| greater portfolio choice (G11) | take speculative positions (G13) |
| high elasticity of intertemporal substitution (D15) | greater choice leads to increased perceived risk-adjusted returns (G11) |
| greater choice leads to increased perceived risk-adjusted returns (G11) | motivates higher savings (D14) |
| stock market participation (G10) | save more than nonparticipants (D14) |
| increased market participation (G10) | reduces the risk premium (G12) |
| increased market participation (G10) | raises the risk-free rate (E43) |