Working Paper: NBER ID: w29604
Authors: Mark L. Egan; Alexander Mackay; Hanbin Yang
Abstract: We present a portfolio choice demand model that allows for the nonparametric estimation of investors’ (subjective) expectations and risk preferences. Utilizing a comprehensive dataset of 401(k) plans from 2009 through 2019, we explore heterogeneity in asset allocations across plans using our empirical framework. This framework enables us to recover investors’ beliefs about each asset and examine the implications and potential sources of those beliefs. Our estimates suggest that heterogeneity in expectations across investors accounts for twice as much variation in portfolio holdings as heterogeneity in risk aversion. Belief heterogeneity is driven in part by the idiosyncratic characteristics and experiences of investors, reflecting local sources of information such as county-level GDP and employers’ past performance. Our findings suggest that, to the extent it is distortive, belief heterogeneity imposes modest costs on the median investor in terms of foregone annual returns, though the costs for the upper quartile are significant.
Keywords: Portfolio Choice; Risk Preferences; Investor Behavior; 401k Plans; Subjective Expectations
JEL Codes: G00; G11; G12; G40; G5; G51; J32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fund expense ratios (G32) | demand for funds (E41) |
| local economic conditions (R11) | investor beliefs about expected returns (G11) |
| wealth and education (I24) | investor expectations about market returns (G17) |
| age and minority status (J15) | investor expectations about market returns (G17) |
| demographic factors (J11) | risk aversion (D81) |
| subjective expectations and risk preferences (D81) | investment behavior (G11) |