Down or Out: Assessing the Welfare Costs of Household Investment Mistakes

65 Pages Posted: 21 Feb 2006

See all articles by Laurent E. Calvet

Laurent E. Calvet

SKEMA Business School; CEPR

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Paolo Sodini

Stockholm School of Economics - Department of Finance; Swedish House of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: February 2006

Abstract

This paper investigates the efficiency of household investment decisions in a unique dataset containing the disaggregated wealth and income of the entire population of Sweden. The analysis focuses on two main sources of inefficiency in the financial portfolio: underdiversification of risky assets ("down") and nonparticipation in risky asset markets ("out"). We find that while a few households are very poorly diversified, the cost of diversification mistakes is quite modest for most of the population. For instance, a majority of participating Swedish households are sufficiently diversified internationally to outperform the Sharpe ratio of their domestic stock market. We document that households with greater financial sophistication tend to invest more efficiently but also more aggressively, so the welfare cost of portfolio inefficiency tends to be greater for these households. The welfare cost of nonparticipation is smaller by almost one half when we take account of the fact that nonparticipants would be unlikely to invest efficiently if they participated in risky asset markets.

Keywords: Asset allocation, diversification, familiarity, participation

JEL Classification: D5, D9, E3, O1

Suggested Citation

Calvet, Laurent E. and Campbell, John Y. and Sodini, Paolo, Down or Out: Assessing the Welfare Costs of Household Investment Mistakes (February 2006). Harvard Institute of Economic Research Discussion Paper No. 2107, Riksbank Research Paper Series No. 28, Riksbank Working Paper No. 195, Available at SSRN: https://ssrn.com/abstract=881768 or http://dx.doi.org/10.2139/ssrn.881768

Laurent E. Calvet

SKEMA Business School ( email )

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CEPR ( email )

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John Y. Campbell (Contact Author)

Harvard University - Department of Economics ( email )

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Paolo Sodini

Stockholm School of Economics - Department of Finance ( email )

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