Risk Preferences and Efficiency of Household Portfolios

TL;DR

This paper introduces a new method to infer investors' risk preferences from their portfolio choices and assesses portfolio efficiency, revealing that wealth, financial literacy, and retirement accounts are linked to more efficient investments.

Contribution

It presents a novel approach to estimate risk preferences from portfolio data and links these preferences to portfolio efficiency, considering demographic and financial literacy factors.

Findings

Implied risk aversion increases with wealth and financial literacy.

More efficient portfolios are associated with higher diversification, Sharpe ratio, and returns.

Affluent, educated investors with retirement accounts hold more efficient portfolios.

Abstract

We propose a novel approach to infer investors' risk preferences from their portfolio choices, and then use the implied risk preferences to measure the efficiency of investment portfolios. We analyze a dataset spanning a period of six years, consisting of end of month stock trading records, along with investors' demographic information and self-assessed financial knowledge. Unlike estimates of risk aversion based on the share of risky assets, our statistical analysis suggests that the implied risk aversion coefficient of an investor increases with her wealth and financial literacy. Portfolio diversification, Sharpe ratio, and expected portfolio returns correlate positively with the efficiency of the portfolio, whereas a higher standard deviation reduces the efficiency of the portfolio. We find that affluent and financially educated investors as well as those holding retirement related accounts hold more efficient portfolios.