More Possessions, More Worry
41 Pages Posted: 9 Feb 2014 Last revised: 3 Apr 2014
Date Written: February 7, 2014
A common wisdom asserts that the wider the universe of assets to choose from the greater the investor’s welfare. We show that this is not the case in practice where parameters have to be estimated even when the estimates are unbiased. Surprisingly, risk aversion plays a crucial and rather uncommon role corresponding to the desirability of asset expansion by dividing investors in three groups: we find that Investors with very low (group 1) and investors with very high (group 2) risk tolerance are better-off with asset expansion and investors with moderate risk tolerance (group 3) are worse-off despite the option to refrain from investing in the additional asset. These results have implication to the CAPM, the existence of mutual funds and the observed small portfolios held by investors.
Keywords: portfolio theory, estimation risk, CAPM, rational choice, optimization under estimation risk
JEL Classification: C, G
Suggested Citation: Suggested Citation