Welfare effects of information and rationality in portfolio decisions under parameter uncertainty

TL;DR

This paper examines how information and rationality affect portfolio decisions under parameter uncertainty, comparing bounded rational strategies and full information scenarios, with implications for DIY investors versus professional management.

Contribution

It quantifies the utility effects of bounded rationality and information in portfolio choices, highlighting the marginal role of learning and motivations for delegation to professionals.

Findings

Full information and predictability significantly impact utility effects.

Learning effects are marginal compared to information availability.

Delegation motivations vary with investment horizon and risk aversion.

Abstract

We analyze and quantify, in a financial market with parameter uncertainty and for a Constant Relative Risk Aversion investor, the utility effects of two different boundedly rational (i.e., sub-optimal) investment strategies (namely, myopic and unconditional strategies) and compare them between each other and with the utility effect of full information. We show that effects are mainly caused by full information and predictability, being the effect of learning marginal. We also investigate the saver's decision of whether to manage her/his portfolio personally (DIY investor) or hire, against the payment of a management fee, a professional investor and find that delegation is mainly motivated by the belief that professional advisors are, depending on investment horizon and risk aversion, either better informed ("insiders") or more capable of gathering and processing information rather than their ability of learning from financial data. In particular, for very short investment horizons, delegation is primarily, if not exclusively, motivated by the beliefs that professional investors are better informed.