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Resuscitating Businessman Risk: A Rationale for Familiarity-Based Portfolios

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  • Doriana Ruffino

    (University of Minnesota)

Abstract

This paper studies two frequently observed portfolio behaviors that are seemingly inconsistent with rational portfolio choice. The first is the tendency of workers and entrepreneurs to hold their company's stock. The second is the propensity of workers to limit their equity holdings through time. The explanation offered here for both of these behaviors lies in the option to switch jobs when one's company does poorly. This is equivalent to holding put options on one's own company stock and call options on the other company's stock, where both options must be exercised at the same time. Given these initial undiversified implicit financial holdings, workers need to allocate a relatively large share of their regular financial assets to their own company's stock and a relatively small share to the stock of their alternative employment simply to restore overall portfolio balance. Although this effect can only create some hedging demand for company's stock, it is a factor of potentially major import for assessing the suitability of workers' financial decisions. I find that, under certain conditions, workers optimally hold almost 40% of their financial wealth in their company's stock. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2013.03.003
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 17 (2014)
Issue (Month): 1 (January)
Pages: 107-130

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Handle: RePEc:red:issued:11-295

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Keywords: Life-cycle modeling; Industry-specific risk; Job-switching options; Portfolio choice; Familarity-based investments; Businessman risk;

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References

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Cited by:
  1. Annamaria Lusardi & Olivia S. Mitchell & Vilsa Curto, 2012. "Financial Sophistication in the Older Population," NBER Working Papers 17863, National Bureau of Economic Research, Inc.

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