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Why does junior put all his eggs in one basket? A potential rational explanation for holding concentrated portfolios

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  • Roche, Hervé
  • Tompaidis, Stathis
  • Yang, Chunyu

Abstract

Empirical studies of household portfolios show that young households, with little financial wealth, hold underdiversified portfolios that are concentrated in a small number of assets, a fact often attributed to behavioral biases. We present a potential rational alternative: we show that investors with little financial wealth, who receive labor income, rationally limit the number of assets they invest in when faced with financial constraints such as margin requirements and restrictions on borrowing. We provide theoretical and numerical support for our results and identify the ratio of financial wealth to labor income as a useful control variable for household portfolio studies.

Suggested Citation

  • Roche, Hervé & Tompaidis, Stathis & Yang, Chunyu, 2013. "Why does junior put all his eggs in one basket? A potential rational explanation for holding concentrated portfolios," Journal of Financial Economics, Elsevier, vol. 109(3), pages 775-796.
    • Handle: RePEc:eee:jfinec:v:109:y:2013:i:3:p:775-796
    DOI: 10.1016/j.jfineco.2013.03.016
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    8. Turan G. Bali & Nusret Cakici & Robert F. Whitelaw, 2013. "Hybrid Tail Risk and Expected Stock Returns: When Does the Tail Wag the Dog?," NBER Working Papers 19460, National Bureau of Economic Research, Inc.
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    More about this item

    Keywords

    Asset selection; Underdiversification; Labor income; Financial constraints; Household portfolios;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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