Investor Behavior: The Psychology of Financial Planning and Investing

CHAPTER 22

Diversification and Asset Allocation Puzzles

Dimitris Georgarakos

Assistant Professor, Goethe University Frankfurt, Senior Economist, DG-Research, European Central Bank, Research Fellow, Center for Financial Studies

INTRODUCTION

Asset allocation and portfolio diversification decisions have recently received considerable attention from academics, financial practitioners, and policy makers. A debate centers on the investment decisions that households make. Empirical studies that examine these decisions, using either household survey data representative to the entire population or administrative data from various sources, often conclude that the observed behavior differs from what theoretical models predict.

This chapter describes empirical regularities documented by existing research that often deviate from standard theoretical models of optimal behavior. Campbell (2006) and Guiso and Sodini (2012) provide extensive reviews of the growing household finance literature. The chapter examines three major issues. The first issue regards the limited stock market participation that is well documented in numerous studies across various countries. Researchers have put forth various explanations for the so-called household stock market participation puzzle. These include fixed costs that such participation entails, a lack of financial literacy, poor cultural traits, and certain behavioral biases. In the context of stock investing, the chapter also examines why investors exit markets ...