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
Date Written: February 10, 2014
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: Suggested Citation