American Economic Review Vol. 109 No. 3 2019
Does Household Finance Matter? Small Financial Errors with Large Social Costs
Abstract
Households with familiarity biases tilt their portfolios toward a few risky assets. The resulting mean-variance loss from portfolio underdiversification is equivalent to only a modest reduction of about 1 percent per year in a household’s portfolio return. However, once we consider also the effect of familiarity biases on the asset- allocation and intertemporal consumption-savings decisions, the welfare loss is multiplied by a factor of four. In general equilibrium, the suboptimal decisions of households distort also aggregate growth, amplifying further the overall social welfare loss. Our findings demonstrate that financial markets are not a mere sideshow to the real economy and that improving the financial decisions of households can lead to large benefits, not just for individual households, but also for society.
- DOI
- 10.1257/aer.20161076
- Volume
- 109
- Issue
- 3
- Pages
- 1116-1154
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref