Working Paper: CEPR ID: DP15116
Authors: Adrian Buss; Raman Uppal; Grigory Vilkov
Abstract: We develop a simple dynamic general-equilibrium framework that can jointly rationalize many empirically observed features of household portfolios, investment returns, and wealth dynamics. The model differs from traditional models only along a single, natural dimension: households differ in their confidence about the return processes for risky assets. Less-confident households (but with unbiased beliefs) overinvest in safe assets, hold underdiversified portfolios concentrated in familiar assets, are trend chasers, and earn lower absolute and risk-adjusted investment returns. More confident households hold riskier positions and exhibit superior market-timing abilities. Despite Bayesian learning, this investment behavior persists for long periods, thereby exacerbating wealth inequality.
Keywords: household finance; portfolio dynamics; wealth inequality; belief formation; investors expectations; trend chasing; market timing
JEL Codes: D53; G11; G51; G53
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Investor confidence (G24) | Asset allocation decisions (G11) |
| Asset allocation decisions (G11) | Investment returns (G11) |
| Investor confidence (G24) | Investment returns (G11) |
| Less-confident households (D19) | Underdiversified portfolios (G11) |
| Less-confident households (D19) | Lower risk-adjusted returns (G11) |
| More-confident households (D19) | Higher risk-adjusted returns (G11) |
| Differences in confidence (C12) | Persistent heterogeneity in investment behavior (G40) |
| Less-confident households (D19) | Slower wealth accumulation (E21) |