The Influence of Investors' Jobs on Portfolios: Is there an Own Industry Bias?

Abstract:     
According to financial theory, the assets in rational investors' portfolios should have low or negative correlation to each other to minimize overall risk. The major component of most investors' wealth is the discounted value of (non-tradeable) future labor income and therefore an important background risk which should be adequately hedged by financial portfolio risk.

We test this hypothesis empirically by using a unique data set of 30,000 private investors whose profession and detailed portfolio composition we know. We find that investors hold significantly higher ratios of equity in their own industry than peers from other industries - an own industry bias. So investors tend not only to ignore but to increase background risk in their overall wealth by holding biased financial portfolios.

Rational and financially sophisticated investors hedge their labor income risk better. In contrast, a short event study shows that unsophisticated investors cannot expect to reduce their own industry bias by taking financial advice.

Number of Pages in PDF File: 25

Keywords: Background Risk, Labor Income, Household Portfolios, Asset Allocation, Behavioral Finance

JEL Classification: D12, D10, G29

working papers series