Does Household Finance Matter? Small Financial Errors with Large Social Costs

108 Pages Posted: 27 Jan 2016 Last revised: 1 Oct 2018

See all articles by Harjoat Singh Bhamra

Harjoat Singh Bhamra

Imperial College Business School

Raman Uppal

EDHEC Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: September 17, 2018

Abstract

Households with familiarity biases tilt their portfolios toward a few risky assets. The resulting mean-variance loss from portfolio underdiversification is equivalent to only a modest reduction of about 1 percent per year in a household's portfolio return. However, once we consider also the effect of familiarity biases on the asset-allocation and intertemporal consumption-savings decisions, the welfare loss is multiplied by a factor of four. In general equilibrium, the suboptimal decisions of households distort also aggregate growth, amplifying further the overall social welfare loss. Our findings demonstrate that financial markets are not a mere sideshow to the real economy and that improving the financial decisions of households can lead to large benefits, not just for individual households, but also for society.

Keywords: Portfolio choice, underdiversification bias, growth, social welfare

JEL Classification: G11, E44, E03, G02

Suggested Citation

Bhamra, Harjoat Singh and Uppal, Raman, Does Household Finance Matter? Small Financial Errors with Large Social Costs (September 17, 2018). Available at SSRN: https://ssrn.com/abstract=2722803 or http://dx.doi.org/10.2139/ssrn.2722803

Harjoat Singh Bhamra (Contact Author)

Imperial College Business School ( email )

Tanaka Building
Exhibition Rd
London, SW7 2AZ
United Kingdom

HOME PAGE: http://www.harjoatbhamra.com

Raman Uppal

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

Centre for Economic Policy Research (CEPR)

90-98 Goswell Road
London, EC1V 7RR
United Kingdom

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