Working Paper: CEPR ID: DP5901
Authors: Luigi Guiso; Tullio Jappelli
Abstract: Rational investors perceive correctly the value of financial information. Investment in information is therefore rewarded with a higher Sharpe ratio. Overconfident investors overstate the quality of their own information, and thus attain a lower Sharpe ratio. We contrast the implications of the two models using a unique survey of customers of an Italian leading bank with portfolio data and measures of financial information. We find that the portfolio Sharpe ratio is negatively associated with investment in information. The negative correlation is stronger for men than women and for those who claim they know stocks well, arguably because these investors are more likely to be overconfident. We also show that investment in information is associated with more frequent trading, less delegation of portfolio decisions and less diversified portfolios. In each case, the effect of information is stronger for investors who, a priori, are suspected to be more overconfident.
Keywords: behavioral finance; overconfidence; portfolio choice; rationality
JEL Codes: D8; E2; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| rational investors (G40) | higher portfolio Sharpe ratio (G11) |
| overconfident investors (G41) | lower portfolio Sharpe ratio (G11) |
| investment in information (D83) | more frequent trading (G14) |
| investment in information (D83) | less delegation of portfolio decisions (G11) |
| investment in information (D83) | less diversified portfolios (G11) |
| more frequent trading (G14) | impact on performance (D29) |
| less delegation of portfolio decisions (G11) | impact on performance (D29) |
| less diversified portfolios (G11) | impact on performance (D29) |