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Investor Sophistication and Portfolio Dynamics

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  • Buss, Adrian
  • Uppal, Raman
  • Vilkov, Grigory

Abstract

We develop a dynamic general-equilibrium framework with multiple households and multiple risky assets to explain how less- and more-sophisticated households differ in their portfolio and wealth dynamics. Differences in sophistication are modeled via heterogeneous confidence about asset returns, coupled with Bayesian learning. Consistent with recent empirical evidence, less-sophisticated households overinvest in safe assets, hold underdiversified portfolios concentrated in familiar assets, are trend chasers, and earn lower absolute and risk-adjusted investment returns. Notably, this behavior is a consequence of optimal choices rather than investment mistakes. The model explains why this behavior, despite learning, persists for long periods, thereby exacerbating wealth inequality.

Suggested Citation

  • Buss, Adrian & Uppal, Raman & Vilkov, Grigory, 2020. "Investor Sophistication and Portfolio Dynamics," CEPR Discussion Papers 15116, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:15116
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    More about this item

    Keywords

    Belief formation; household finance; investors' expectations; trend chasing; Wealth Inequality;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth
    • G53 - Financial Economics - - Household Finance - - - Financial Literacy

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