SEMINAR 27 February 2012: Hans-Martin von Gaudecker, University of Mannheim

How Does Household Portfolio Diversification Vary with Financial Literacy and Financial Advice?

Abstract

Economic theory suggests that households should invest their financial wealth in a combination of cash and a well-diversified equity portfolio. Yet, many households’ equity investments are strongly concentrated in a few assets. Attempts to explain this discrepancy have included low levels of financial literacy and the absence of or misguided financial advice. In order to investigate these claims empirically, I construct detailed portfolios for the respondents to a Dutch household survey. The data allow me to estimate the portfolios’ risk-return properties without resorting to assumptions about characteristics of specific asset classes. Controlling for a large number of covariates, my results show that the combination of low numerical-financial skills and not seeking advice from other persons is strongly associated with the largest expected losses from underdiversification, whereas financial knowledge does not seem to have an effect.

JEL codes: D14, D12, G11

Keywords: Household portfolios, diversification, financial literacy, financial advice.