Diversification Decisions of Individual Investors and Asset Prices
AbstractIn this paper, we examine if the diversification decisions of individual investors influence asset prices. First, we show that a vast majority of individual investors in our sample are under-diversified and the unexpectedly high idiosyncratic risk in their portfolios results in a welfare loss - the least diversified group of investors earn 2.40% lower return annually than the most diversified group of investors on a risk-adjusted basis. Next, we examine the determinants of investors' under-diversification and find that younger, low-income, and relatively less sophisticated investors hold less diversified portfolios. In addition, investors who prefer skewness, exhibit relatively stronger familiarity bias, and exhibit greater over-confidence are less diversified. Finally, we show that the systematic under-diversification of individual investors influence asset prices. A zero-cost portfolio (DIV factor) that takes a long position in stocks with the least diversified individual investor clientele and a short position in stocks with the most diversified individual investor clientele earns an annual excess return of 7.44% on a risk-adjusted basis. Furthermore, this factor has power to explain the cross-sectional variation in returns for a considerable group of stocks
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Bibliographic InfoPaper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm441.
Date of creation: 21 Nov 2003
Date of revision:
Individual investors; Diversification; Idiosyncratic risk; Behavioral biases; Asset pricing.;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-07-18 (All new papers)
- NEP-CFN-2004-07-18 (Corporate Finance)
- NEP-FIN-2004-07-18 (Finance)
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- Gina Nicolosi & Liang Peng & Ning Zhu, 2003.
"Do Individual Investors Learn from Their Trading Experience?,"
Yale School of Management Working Papers
ysm439, Yale School of Management, revised 01 Sep 2009.
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