The aggregate cost of equity underdiversification

Florentsen, Bjarne; Nielsson, Ulf; Raahauge, Peter; Rangvid, Jesper

doi:10.1111/fire.12212

Cited by 10 publications

(7 citation statements)

References 35 publications

(64 reference statements)

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“… See Shefrin and Statman (2000),Polkovnichenko (2005),Barberis and Huang (2008),Chapman and Polkovnichenko (2011), De Giorgi and Legg (2012),Carlson and Lazrak (2016),and He, Kouwenberg, and Zhou (2018).4 See,Blume and Friend (1975),Kelly (1995),Calvet, Campbell, and Sodini (2007),Mitton and Vorkink (2007),Goetzmann and Kumar (2008), and von Gaudecker (2015),Florentsen, Nielsson, Raahauge, and Rangvid (2019).5 For equities see,Boyer, Mitton, and Vorkink (2010),Bali, Cakici, and Whitelaw (2011),Conrad, Dittmar, and Ghysels (2013),Conrad, Kapadia, and Xing (2014),and Jiang, Wen, Zhou, and Zhu (2020). For options, see,Boyer and Vorkink (2014) andLi, Subrahmanyam, and Yang (2018).…”

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confidence: 99%

Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

et al. 2018

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We test whether probability weighting affects household portfolio choice in a representative survey. On average, people display inverseS shaped probability weighting, overweighting low probability events. As theory predicts, probability weighting is positively associated with portfolio underdiversification and significant Sharpe ratio losses. Analyzing respondents' individual stock holdings, we find higher probability weighting is associated with owning lottery-type stocks and positively-skewed equity portfolios. People with higher probability weighting are less likely to own mutual funds and more likely to either avoid equities or hold individual stocks. We are the first to empirically link individuals' elicited probability weighting and real-world decisions under risk.

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Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

et al. 2018

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“…3. See Statman (1987), Meulbroek (2005), and Goetzmann and Kumar (2008). See also Aliu et al (2021), Bhamra and Uppal (2019), Florentsen et al (2019), Sukcharoen and Leatham (2016) and Valadkhani et al (2008). …”

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confidence: 99%

Underdiversification puzzle, volatility puzzle and equity premium puzzle: a common solution

Ardalan

2022

SEF

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Purpose The purpose of this paper is to use some of the contributions of the option pricing theory to solve three outstanding puzzles in finance: the underdiversification puzzle, the volatility puzzle and the equity premium puzzle. Design/methodology/approach To approach the issue, this paper considers the applications of the option pricing theory to both sides of the corporate balance sheet. Applications to the left-hand side of the balance sheet has led to the real options theory that has expressed the value of a capital budgeting project as the sum of the values of its “discounted cash flow (DCF) method” and “real options.” This paper argues that, because the balance sheet must balance, the value of equity, which appears on the right-hand side of the balance sheet, should also be expressed as the sum of the values of its “DCF method” and “equity options.” Findings This proposed model of equity valuation solves the three outstanding puzzles in finance: the underdiversification puzzle, the volatility puzzle and the equity premium puzzle. Research limitations/implications This study may not be able to explain the full extent of the three puzzles. Practical implications The dividend discount model of equity valuation needs to be augmented by an option component. Social implications The community of finance scholars will become more confident of their scholarly work because three puzzles will be solved to a great extent. Originality/value To the best of author’s knowledge, the extant literature does not either solve any single one of the three puzzles through the contributions of option pricing theory or solve all three puzzles at the same time with a single solution. The originality of this paper is that it makes both of these contributions to the extant literature.

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“…Florentsen et al (2019) is one of the few studies that measures the aggregate cost of under-diversification because they have access to data that contain information on all retail investors in Denmark.…”

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Modelling the composition of household portfolios: A latent class approach

Alzuabi,

Brown,

Harris

et al. 2023

Canadian J of Economics

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We explore portfolio allocation in Great Britain by introducing a latent class modelling approach using household panel data based on a nationally representative sample of the population, namely the Wealth and Assets Survey. The latent class aspect of the model splits households into four groups, from lowest‐wealth and least‐diversified through to highest‐wealth and most‐diversified, which serves to unveil a more detailed picture of the determinants of portfolio diversification than existing econometric approaches. A pattern of class heterogeneity is revealed that conventional econometric models are unable to identify because the statistical significance and the direction of the effect of some explanatory variables vary across the groups. For example, the effect of labour income on the number of financial assets held influences the level of diversification for the two middle classes, whereas no effect is found for households with the lowest or the highest levels of diversification. Noticeable differences in the magnitude of the effects of pension wealth and occupation are also revealed across the four classes. Such findings demonstrate the importance of accounting for latent heterogeneity when modelling financial behaviour. Ultimately, treating the population as a single homogeneous group may lead to biased parameter estimates, whereby policy based on such models could be inappropriate or erroneous.

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The aggregate cost of equity underdiversification

Cited by 10 publications

References 35 publications

Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

Household Portfolio Underdiversification and Probability Weighting: Evidence from the Field

Underdiversification puzzle, volatility puzzle and equity premium puzzle: a common solution

Modelling the composition of household portfolios: A latent class approach

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