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

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Author Info
Calvet, Laurent E. () (Department of Finance, HEC School of Management and CREST)
Campbell, John Y. () (Department of Economics, Littauer Center)
Sodini, Paolo () (Department of Finance, Stockholm School of Economics)

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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.

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Publisher Info
Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 195.

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Length: 69 pages
Date of creation: 01 May 2006
Date of revision:
Handle: RePEc:hhs:rbnkwp:0195

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Related research
Keywords: Asset allocation; Diversification; Familiarity; Participation;

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Find related papers by JEL classification:
D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
D90 - Microeconomics - - Intertemporal Choice and Growth - - - General
E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
O10 - Economic Development, Technological Change, and Growth - - Economic Development - - - General

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bruce I. Carlin & Simon Gervais, 2009. "Legal Protection in Retail Financial Markets," NBER Working Papers 14972, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Luigi Guiso & Tullio Jappelli, 2007. "Information Acquisition and Portfolio Performance," Economics Working Papers ECO2007/45, European University Institute. [Downloadable!]
    Other versions:
  3. Raffaele Miniaci & Sergio Pastorello, 2008. "Mean-Variance Econometric Analysis of Household Portfolios," Working Papers 0807, University of Brescia, Department of Economics. [Downloadable!]
  4. Bilias, Yannis & Georgarakos, Dimitris & Haliassos, Michalis, 2009. "Portfolio Inertia and Stock Market Fluctuations," CEPR Discussion Papers 7239, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  5. Annamaria Lusardi & Olivia S. Mitchell, 2006. "Baby Boomer Retirement Security: The Roles of Planning, Financial Literacy, and Housing Wealth," Working Papers wp114, University of Michigan, Michigan Retirement Research Center. [Downloadable!]
    Other versions:
  6. Ødegaard, Bernt Arne, 2009. "Who moves stock prices? Monthly evidence," UiS Working Papers in Economics and Finance 2009/4, University of Stavanger. [Downloadable!]
  7. Dahlquist, Magnus & Robertsson, Göran & Rydqvist, Kristian, 2007. "Direct Evidence of Dividend Tax Clienteles," SIFR Research Report Series 51, Institute for Financial Research. [Downloadable!]
  8. Juergen Jung, 2008. "The Timing of Redistribution," Caepr Working Papers 2008-015, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington. [Downloadable!]
  9. Tobias Broer, 2008. "The home bias of the poor: terms of trade effects and portfolios across the wealth distribution," Economics Working Papers ECO2008/28, European University Institute. [Downloadable!]
  10. Dahlquist, Magnus & Robertsson, Göran & Rydqvist, Kristian, 2006. "Direct Evidence of Dividend Tax Clienteles," CEPR Discussion Papers 6005, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  11. Annamaria Lusardi & Olivia S. Mitchell, 2006. "Financial Literacy and Planning: Implications for Retirement Wellbeing," DNB Working Papers 078, Netherlands Central Bank, Research Department. [Downloadable!]
    Other versions:
  12. George M. Korniotis & Alok Kumar, 2008. "Do behavioral biases adversely affect the macro-economy?," Finance and Economics Discussion Series 2008-49, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  13. Timotheos Angelidis & Nikolaos Tessaromatis, 2009. "The Efficiency of Greek Public Pension Fund Portfolios," Working Papers 0035, University of Peloponnese, Department of Economics. [Downloadable!]
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    Other versions:
  16. Anthony Tay & Jacques Olivier, 2008. "Time-Varying Incentives in the Mutual Fund Industry," Working Papers 10-2008, Singapore Management University, School of Economics, revised Jun 2008. [Downloadable!]
  17. Laurent E. Calvet & John Y. Campbell & Paolo Sodini, 2009. "Measuring the Financial Sophistication of Households," NBER Working Papers 14699, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  18. Olivier, Jacques & Tay, Anthony, 2008. "Time-Varying Incentives in the Mutual Fund Industry," CEPR Discussion Papers 6893, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  19. Ning Tang & Olivia S. Mitchell, 2008. "The Efficiency of Pension Plan Investment Menus: Investment Choices in Defined Contribution Pension Plans," Working Papers wp176, University of Michigan, Michigan Retirement Research Center. [Downloadable!]
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