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An Asset Allocation Puzzle

Author

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  • Niko Canner
  • N. Gregory Mankiw
  • David N. Weil

Abstract

This paper examines popular advice on portfolio allocation among cash, bonds, and stocks. It documents that this advice is inconsistent with the mutual-fund separation theorem, which states that all investors should hold the same composition of risky assets. In contrast to the theorem, popular advisors recommend that aggressive investors hold a lower ratio of bonds to stocks than conservative investors. The paper explores various possible explanations of this puzzle. It concludes that the portfolio recommendations can be explained if popular advisors base their advice on the unconditional distribution of nominal returns. It also finds that the cost of this money illusion is small, as measured by the distance of the recommended portfolios from the mean-variance efficient frontier.

Suggested Citation

  • Niko Canner & N. Gregory Mankiw & David N. Weil, 1994. "An Asset Allocation Puzzle," NBER Working Papers 4857, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:4857
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    References listed on IDEAS

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    1. Campbell, John Y. & Hentschel, Ludger, 1992. "No news is good news *1: An asymmetric model of changing volatility in stock returns," Journal of Financial Economics, Elsevier, vol. 31(3), pages 281-318, June.
    2. Stanley Fischer, 1983. "Investing for the Short and the Long Term," NBER Chapters, in: Financial Aspects of the United States Pension System, pages 153-176, National Bureau of Economic Research, Inc.
    3. Eldar Shafir & Peter Diamond & Amos Tversky, 1997. "Money Illusion," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 341-374.
    4. Campbell, John Y., 1987. "Stock returns and the term structure," Journal of Financial Economics, Elsevier, vol. 18(2), pages 373-399, June.
    5. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    6. Akerlof, George A & Yellen, Janet L, 1985. "Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria?," American Economic Review, American Economic Association, vol. 75(4), pages 708-720, September.
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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