Does Household Finance Matter? Small Financial Errors with Large Social Costs

Harjoat Bhamra and Raman Uppal

American Economic Review, 2019, vol. 109, issue 3, 1116-54

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.

JEL-codes: D14 D91 E21 E44 G11 G41 (search for similar items in EconPapers)
Date: 2019
Note: DOI: 10.1257/aer.20161076
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Citations: View citations in EconPapers (16)

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Working Paper: Does Household Finance Matter? Small Financial Errors with Large Social Costs (2017)
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