Why Do Individual Investors Hold Under-Diversified Portfolios?

William Goetzmann and Alok Kumar ()
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Alok Kumar: University of Notre Dame - Department of Finance

Yale School of Management Working Papers from Yale School of Management

Abstract: This study examines the diversification decisions of more than 60,000 individual investors during a six year period (1991-96) in recent U.S. capital market history. The majority of investors in our sample are under-diversified and the extent of under-diversification is more severe in retirement accounts. Investors' personal characteristics, their stock preferences, and their behavioral biases jointly influence their diversification choices. Younger, lower-income (less wealthy), and relatively less sophisticated investors and those who follow price trends, prefer local (familiar) stocks, and exhibit over-confidence hold relatively less diversified portfolios. Under-diversified investors exhibit strong style and industry preferences and they also prefer more volatile and positively skewed stocks. Furthermore, we find some evidence to support the asymmetric information hypothesis for under diversification. In contrast, we find that factors such as small portfolio size, transaction costs, and search costs are unlikely determinants of investors' diversification choices. The unexpectedly high idiosyncratic risk in investors' portfolios results in a welfare loss.

JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2005-04-14
New Economics Papers: this item is included in nep-fin and nep-rmg
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Citations: View citations in EconPapers (22)

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Persistent link: https://EconPapers.repec.org/RePEc:ysm:somwrk:ysm454

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