Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Some Empirical Puzzles in Portfolio Allocation
Ali Lazrak
University of British Columbia
Sauder School of Business
April 2007
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Survey Data Sets in the US
Panel Study of Income Dynamics (PSID)
http://psidonline.isr.umich.edu/
Longitudinal study of nearly 8,000 households since 1968.
PSID collects data on economics, health and social behaviour.
Data, tutorials, codebook and guides available for free on line.
Survey of Consumer Finances (SCF)
http://www.federalreserve.gov/pubs/OSS/oss2/scfindex.html
Survey conducted every 3 years since 1992. 4,500 voluntary
families take part in the survey.
Focuses on U.S. family …nances. (balance sheet, pension,
income, and use of …nancial institutions).
Places stronger emphasis on family …nances than PSID.
Data, tutorials, codebook and guides available for free on line.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Some Empirical Puzzles
Normative Portfolio Allocation
Merton’s Portfolio Problem
Some Empirical Portfolio Puzzles
I) Lack of Participation in Stock Markets
II) Portfolio Composition
Underallocation towards stocks
Underdiversi…cation
III) Equity Allocation is increasing in Wealth
IV) Investors Do Not Hedge Non-Financial Risks
V) Popular Investment Advise is not Mean-Variance E¢ cient
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Normative Portfolio Allocation. The Merton Portfolio Allocation Case.
Historical Returns and Implications for Equityholdings
Fama-French Value Weighted Portfolio
and 3 Month Treasury (Jan 1980 - Dec. 1991)
µ
σ
rf
16.02% 16.73%
8.21%
µ r
Merton Portfolio Choice Allocation in Equity α = γ1 σ2 f
γ
2
5
7
10
15
α 140% 55.85% 39.89% 27.92%
18.62%
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underparticipation
Stock Market Participation Rates in US
Table 1: Participation Rates in the US according to calendar years
Year
Direct Mutual Funds
Direct Equity
All Account Types
1989
6%
12.6%
31.8%
1992
8.4%
11.1%
36.7%
1995
11.3%
10.5%
40.4%
1998
15.2%
10.4%
48.9%
2001
16.7%
9.8%
51.9%
Table 3 of Curcuru, Heaton, Lucas & Moore (2004).
Stock Market Participation rates directly and Indirectly.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underparticipation
Stock Market Participation Rates in Sweden
Table 2: Participation Rates in Sweden
Year
1995
1996
1997
1998
1999
Security Market
5.1%
5.5%
20.0%
21.1%
16.4%
Real Estate Market
55.1%
54.1%
53.5%
53.8%
54.1%
Bank Loan
7.0%
9.6%
9.9%
9.6%
10.5%
Table C of Massa and Simonov. Swedish panel data.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underparticipation
Stock Market Participation Rates in European Countries
Table3: Participation Rates in Equity Markets by Country
Direct and Indirect Holdings in 1998
France
Survey
Direct
Total
Germany
Italy
INSEE
Income &
Survey of House-
Center
Survey of
Expenditure
-hold Income &
Saving
Wealth
Survey
Wealth
Survey
15%
17%
7%
14%
23%
-
15%
24%
Sweden
UK
US
KEK-
Family
Survey of
Household
Resources
Consumer
Economy
Survey
Finances
Direct
27%
27%
19%
Total
54%
34%
48%
Survey
Netherlands
Table 4 from Guiso, Haliassos & Jappelli (2002): 1998 …gures except Sweden (1999).
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underparticipation
Stockholders are generally
Stockholders are generally
Wealthier
Have higher levels of education
Have higher labour income
Are more risk tolerant than non-stockholders.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underparticipation
Participants and Non-Participants in the US
Table 4: Characteristics of Stock Market
Participants and Non-Participants
1992
2001
No-Stockholders
Stockholders
Total Financial Wealth
74,799
207,092
Labour Income
25,985
56,919
Education
12
15
Risk Tolerance
4.0
3.0
Percentage of Households
54.76%
45.24%
Total Financial Wealth
77,885
290,850
Labour Income
25,000
65,000
Education
12
15
Risk Tolerance
4.0
3.0
Percentage of Households
44.6%
55.4%
Table 4 of Curcuru, Heaton, Lucas and Moore (2004)
Tabulations are from 1992 and 2001 SCF data
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underparticipation
Some Characteristics of Participants in Sweden
Figure 1: Participation Rates in Wealth Decile.
Figure from Guiso, Haliassos & Jappelli (2002)
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underparticipation
Some Characteristics of Participants in Sweden
Figure 2: Participation Rates across Age group.
Figure from Guiso, Haliassos & Jappelli (2002)
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underparticipation
Characteristics of Participants in Sweden
Figure 3: Participation Rates in Income Decile.
Figure from Guiso, Haliassos & Jappelli (2002)
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underallocation
Underallocation
Stock market participation has increased in the 90’s. But except
for the top quartile wealthiest households, equity composes only a
neglible share of liquid wealth for most stockholders.
Table 5: Distribution: Portfolio Shares in Stocks (subsample medians)
Year
0-25th percentile
25th-75th
75th-100th
Mean
Std Dev
Skewness
1989
0%
0%
4.7%
5.8%
13.3%
3.560
1992
0%
0%
7.7%
7.7%
15.8%
3.005
1995
0%
0%
11.0%
9.9%
18.8%
2.587
1998
0%
2.1%
2.17%
14.0%
21.0%
1.800
2001
0%
4.2%
2.6%
16.2%
22.9%
1.598
Table 2 of Curcuru, Heaton, Lucas and More (2004).
Stock holdings distribution as a percentage of Financial
Wealth across households ranked according to …nancial wealth
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underallocation
Who Holds Most of It? The Wealthy
Table 6: Percentage of all Stocks held by Top Decile Wealthiest
Year
Percent of all traded stocks
1989
84%
1995
83%
2001
76.6%
Source: Curcuru, Heaton, Lucas and More (2004).
Percentage of all stocks held by top decile wealthiest.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underallocation
Wealth composition
Subsequent tables will show that:
Owner-occupied housing is by far the largest asset holding for
households with net worth less than $1M
Stocks are the largest asset holding only for households with
net worth greater than $1M.
Stockholding seems to be increasing in wealth. For the
wealthy, stockholdings seem to be increasing in age. These
are major challenges to portfolio theory (more on these later)
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underallocation
Liquid Assets and Wealth ($10K<Net Worth<$100K)
Table 7: Total Wealth Allocation over Life Cycle (Stockholders Only)
Age
<35
35-44
45-54
55-64
65-74
>75
$10K <Net Worth <$100K
Stocks
5.8%
3.7%
0.9%
0.9%
0.0%
0.0%
Bonds
0.3%
0.6%
0.0%
0.0%
0.0%
0.0%
Cash
3.2%
3.1%
3.1%
2.0%
4.8%
9.1%
Income (in $1,000s)
50.0
46.0
42.0
29.0
20.0
15.0
Table 6 of Curcuru, Heaton, Lucas, More (2004). Based on 2001 SCF data.
All …gures are medians. Means are also reported in the original table.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underallocation
Liquid Assets and Wealth ($100K<Net Worth)
Table 7: Total Wealth Allocation over Life Cycle (Stockholders Only)
<35
35-44
45-54
55-64
65-74
>75
Stocks
12.1%
15.9%
15.7%
15.0%
3.1%
0.0%
Bonds
0.3%
1.0%
1.8%
0.7%
0.0%
0.0%
Cash
3.4%
3.2%
3.6%
3.4%
9.1%
12.0%
Income (in $1,000s)
78.0
77.0
75.0
58.0
37.0
28.0
Stocks
6.1%
20.2%
23.1%
33.4%
30.1%
37.8%
Bonds
0.1%
0.5%
3.3%
4.7%
5.9%
12.1%
Cash
1.3%
2.1%
2.3%
2.4%
3.6%
3.8%
Income (in $1,000s)
130.0
235.0
200.0
168.0
120.0
97.0
Age
$100K <Net Worth <$1M
Net Worth >$1M
Table 6 of Curcuru, Heaton, Lucas, More (2004). Based on 2001 SCF data.
All …gures are medians. Means are also reported in the original table.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underallocation
Housing and Wealth ($10K<Net Worth<$100K)
Table 7: Wealth Allocation over Life Cycle (Stockholders Only)
<35
35-44
45-54
55-64
65-74
>75
Owner-Occupied Housing
70.9%
72.3%
81.4%
85.1%
89.2%
85.1%
Other Real Estate
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Business
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Income (in $1,000s)
50.0
46.0
42.0
29.0
20.0
15.0
Age
$10K <Net Worth <$100K
Table 6 of Curcuru, Heaton, Lucas, More (2004). Based on 2001 SCF data.
All …gures are medians. Means are also reported in the original table.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underallocation
Housing and Wealth ($100K<Net Worth)
Table 7: Wealth Allocation over Life Cycle (Stockholders Only)
Age
<35
35-44
45-54
55-64
65-74
>75
51.6%
51.6%
45.6%
44.1%
46.5%
51.0%
$100K <Net Worth <$1M
Owner-Occupied Housing
Other Real Estate
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Business
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
Income (in $1,000s)
78.0
77.0
75.0
58.0
37.0
28.0
Owner-Occupied Housing
4.3%
22.7%
19.1%
16.1%
16.0%
17.6%
Other Real Estate
0.0%
0.7%
1.8%
2.6%
8.7%
0.8%
Business
28.6%
27.3%
3.2%
0.0%
0.0%
0.0%
Income (in $1,000s)
130.0
235.0
200.0
168.0
120.0
97.0
Net Worth >$1M
Table 6 of Curcuru, Heaton, Lucas, More (2004). Based on 2001 SCF data.
All …gures are medians. Means are also reported in the original table.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Underdiversi…cation
Underdiversi…cation
Underdiversi…cation is a major challenge to …nance theory.
Investor tend to tilt portfolio weights towards
domestic investments (Cooper and Kaplains (1994))
regional company stocks (Zhu (2002))
employer company stocks (Mitchell and Utkus (2003))
and company stocks that communicate in the investors’native
tongue, that are close in proximity and have chief executives of
same cultural background (Grinblatt & Keloharju (2001)
Finnish data).
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Human Capital
Portfolio Theory with Labour Income
Portfolio with Non-Tradeable Human Capital
Labour income growth has been shown to have weak
correlation with stock returns
Thus, agent’s human capital is an implicit holding of a
non-tradeable bond (Bodie, Merton, Samuelson (1992))
For a given level of human capital, the higher the wealth, the
lower the human capital share of total wealth.
As agents age, human capital wealth declines
Stockholding must be decreasing in wealth and age.
But that is not the case in reality.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Portfolio Shares
Increasing Portfolio Share in Wealth
Table 8: Stocks as a Percentage of Financial Wealth
Age
26-35
36-45
46-55
56-65
66-75
0-25th Wealth Percentile
35
39
39
37
34
25-50th Wealth Percentile
42
48
56
51
36
50-75th Wealth Percentile
42
48
56
51
36
75-100th Wealth Percentile
52
52
59
57
54
Top 5th Wealth Percentile
53
56
62
55
58
Table from Watcher and Yogo (2007).
Portfolio share in Equity is increasing in Financial Wealth & Age.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
No Hedging of Background Risk
In presence of non-tradeable risks, investor would
participate in stock markets to hedge away these background
risks
and invest in stocks that have negative correlation with
background risks
Massa and Simonov (2006) show, using detailed Swedish
data, that
investors don’t hedge background risks
investors shift portfolio weights to stocks with positive
correlation with background risks.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
E¢ cient Portfolio Frontier
Investment Advisors are not Mean-Variance E¢ cient
aggressive
moderate
conservative
Figure 4: Markowitz Model. The E¢ cient Portfolio Frontier.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Investment Advice is contrary to E¢ cient Allocation
Table 9: Asset Allocation Advices
Advisor
Cash
Bonds
Stocks
Bonds/Stocks Ratio
Conservative
50%
30%
20%
1.50
Moderate
20%
40%
40%
1.00
Aggressive
5%
30%
65%
0.46
Conservative
50%
30%
20%
1.50
Moderate
10%
40%
50%
0.80
Aggressive
0%
0%
100%
0.0
Conservative
20%
40%
40%
1.00
Moderate
10%
30%
60%
0.50
Aggressive
0%
20%
80%
0.25
Fidelity
Jane Bryant Quinn
New York Times
From Canner, Mankiw & Weil (1997). Bond/Stock Ratios are not constant.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Bibliography
-
Bodie, Z., Merton, R. and Samuelson, W. (1992). Labor Supply Flexibility and
Portfolio Choice in a Life-Cycle Model, Journal of Economic Dynamics and Control,
vo. 15, 427-450.
-
Campbell, John Y. 2006, Household Finance. forthcoming in Journal of Finance
Cooper, Ian, and Evi Kaplains, 1994, Home bias in equity portfolio, in‡ation hedging
and international capital market equilibrium, Review of Financial Studies 7, 45-60.
-
Curcuru, Stephanie, John Heaton, Deborah Lucas, and Damien Moore, 2006,
Heterogeneity and portfolio choice: Theory and Evidence, forthcoming in Yacine
Ait-Sahalia and Lars P. Hensen, eds. Handbook of Financial Econometrics (Elsevier
Science, Amsterdam).
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Guiso, Luigi, Michael Haliassos and Tullio Jappelli (2002). Household stockholding
in Europe: Where do we stand and where do we go? CSEF Working paper No. 88
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Ivkovic, Zoran, Clemens Sialm, and Scott Weisbenner, 2004, Porfolio concentration
and the performance of individual investors, NBER working paper No. 10675.
Puzzles Normative I) Participation II) Portfolio Composition III) Wealth and Equity IV) No Hedging V) Investment Advice
Bibliography
-
Ivkovic, Zoran and Scott Weisbenner, 2003, Local does as local is: Information
content of the geography of individual investors’common stock investments, NBER
working paper No. 9685
-
.Massa, Massimo and Andrei Simonov, 2006, Hedging, familiarity and portfolio
choice, forthcoming Review of Financial Studies.
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Merton, Robert, 1971, Optimum Consumption and Portfolio Rules in a
Continuous-Time Model. Journal of Economic Theory, vol. 3, pp. 373-413.
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Mitchell, Olivia S., and Stephen P. Utukus, 2003, The role of company stock in
de…ned contribution plans, in Olivia S. Mitchell and Kent Smetters, eds. The Pension
Challenge: Risk Transfers and Retirement Income Security (Oxford University Press,
Oxford).
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Zhu, Ning, 2002, The local bias of individual investors, Working Paper, Yale
University.