Chapter 22: Diversification and Asset Allocation Puzzles

Investor Behavior: The Psychology of Financial Planning and Investing. H. Kent Baker and Victor Ricciardi, editors, 403-420, Hoboken, NJ: John Wiley & Sons, Inc. , 2014.

Posted: 31 May 2014

See all articles by Dimitris Georgarakos

Dimitris Georgarakos

European Central Bank (ECB) - Directorate General Research; Center for Financial Studies (CFS)

Date Written: February 10, 2014

Abstract

Asset allocation and portfolio diversification decisions have important welfare and policy implications. This chapter reviews studies that examine three key aspects of financial investing: participation in stock markets, portfolio diversification, and trading behavior. Standard finance theory predicts the optimal investment behavior of rational agents with reference to each of these three aspects. Yet, empirical studies document that observed behavior of investors largely deviates from theory predictions. The chapter also provides a discussion of empirical regularities that point to these deviations such as the limited stock market participation, the poor diversification and reference for domestic securities, and the contrast between excess trading activity of a few wealthy investors and considerable trading inertia exhibited by the majority of the population. These issues become increasingly topical as investors face a richer menu of complex financial instruments and gradually assume higher responsibility for retirement financing.

Keywords: Stock market participation; portfolio diversification; trading frequency; household finance, inertia, behavioral finance, financial psychology, behavioural finance, behavioral economics, behavioural economics

JEL Classification: A12, D81, G00, G30, G10, M00, M10, M41

Suggested Citation

Georgarakos, Dimitris, Chapter 22: Diversification and Asset Allocation Puzzles (February 10, 2014). Investor Behavior: The Psychology of Financial Planning and Investing. H. Kent Baker and Victor Ricciardi, editors, 403-420, Hoboken, NJ: John Wiley & Sons, Inc. , 2014. . Available at SSRN: https://ssrn.com/abstract=2443549

Dimitris Georgarakos (Contact Author)

European Central Bank (ECB) - Directorate General Research ( email )

Sonnemannstrasse 20
Frankfurt am Main, 60314
Germany

Center for Financial Studies (CFS) ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

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