Finance Seminar with Harjoat S. Bhamra, Imperial College Business School

The Department of Finance is proud to announce the upcoming seminar with Harjoat S. Bhamra, Imperial College Business School.

Harjoat S. Bhamra will present

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

Authors:
Harjoat S. Bhamra, Imperial College Business School
Raman Uppal, Edhec Business School

Abstract
Households with familiarity bias tilt their portfolios towards a few risky assets that consequently are underdiversified and excessively volatile. To understand the implications of underdiversification for growth and social welfare, we solve in closed form a model of a stochastic, dynamic, general-equilibrium economy with a large number of heterogeneous firms and households, who bias their investment toward a few familiar assets. Consistent with the existing literature, we find that the direct loss from holding an underdiversified portfolio that is excessively risky is modest. However, this loss from an excessively volatile portfolio is amplified because it increases also household consumption-growth volatility. Moreover, these internalities at the household level are magnified further in general equilibrium through the externality on aggregate investment and growth. Our model demonstrates that even if we force the familiarity biases in portfolios to cancel out across households, their implications for consumption and investment choices do not cancel─individual household biases can have significant aggregate effects. Our results illustrate that financial markets are not a mere sideshow to the real economy and that financial literacy, financial regulation, and financial innovation that improve the financial decisions of households can have a significant positive impact on social welfare.