Financial Risk Aversion and Household Asset Diversification

Abstract

SOEPpapers on Multidisciplinary Panel Data Research at DIW BerlinThis series presents research findings based either directly on data from the German SocioEconomic Panel Study (SOEP) or using SOEP data as part of an internationally comparable data set (e.g. CNEF, ECHP, LIS, LWS, CHER/PACO). SOEP is a truly multidisciplinary household panel study covering a wide range of social and behavioral sciences: economics, sociology, psychology, survey methodology, econometrics and applied statistics, educational science, political science, public health, behavioral genetics, demography, geography, and sport science.The decision to publish a submission in SOEPpapers is made by a board of editors chosen by the DIW Berlin to represent the wide range of disciplines covered by SOEP. There is no external referee process and papers are either accepted or rejected without revision. Papers appear in this series as works in progress and may also appear elsewhere. They often represent preliminary studies and are circulated to encourage discussion. Citation of such a paper should account for its provisional character. A revised version may be requested from the author directly. 1 Financial Risk Aversion and Household Asset DiversificationAbstract This paper explores the relationship between risk attitude and asset diversification in household portfolios. We first examine the impact of manifested risk aversion on the total number of distinct assets held in a portfolio (naive diversification). The second part of the paper focuses on a more sophisticated strategy of diversification and asks whether financial theory is compatible with observed diversification patterns. Based on the German Socioeconomic Panel which provides unique measures of individual propensity for taking risk, the results of the regression analysis show that, along with some socioeconomic characteristics, the propensity for taking investment risk is an important predictor of a household's diversification strategy. However, some of our findings are strongly at odds with what the concept of mean-variance utility suggests. JEL: D14, G11

How Does Households' Wealth Affect Portfolio Choices?

“…Numerous studies discuss their composition and prove their heterogeneity among investors whose risk attitudes differ. However, they also emphasise the popularity of risk-free items (Borsch-Supan and Eymann, 2000;Burton, 2001;Campbell, 2006;Barasinska et al, 2009). According to Campbell et al (2003), the individuals can be divided into those of intermediate level of risk aversion, extremely risk-averse, and risk-loving.…”

“…Benartzi and Thaler (2001) and De Miguel et al (2009) draw attention to the problem of non-professional investors who rely on the naive strategy, which ignores the risk-return profiles of asset types and assumes splitting the wealth evenly among all available items. In turn, Barasinska, Schafer, and Stephan (2009) discuss the portfolio choices of households based on sophisticated strategy, which accounts not only for the number of assets but also for their degree of risk and combination. The authors distinguish three classes of assets held by households characterised by low risk, moderate risk, and high risk.…”

The Private Equity Premium Puzzle Revisited-New Evidence on the Role of Heterogeneous Risk Attitudes

“…Uncertainty is increasing in the level of entrepreneurial investment in the model of Fraser and Greene (2006), for example. In a related study, Barasinska et al (2008) analysed the relationship between riskaversion and the number and combination of different asset classes held by private households. 4.…”

Financial Literacy and Private Old-Age Provision in Germany – Evidence from SAVE 2008

“…They also identify a strong positive correlation between the share of risky assets held in the portfolio and financial sophistication (as measured by the probability to make one of the three mistakes). Barasinska et al (2008) discover that most German households do not diversify their portfolios sufficiently and invest very conservatively. They argue that lack of financial literacy is a cause for not tapping the full potential of diversification and financial literacy of individuals should be improved.…”