Community Effects and Externalities in Portfolio Choice∗
نویسندگان
چکیده
In this paper, we propose an explanation for biases in portfolio choice. We show that if individuals compete for local resources within their community, their utility depends on their own wealth as well as aggregate community wealth. This leads to an externality in portfolio choice. If investors are sufficiently risk averse, then individual investors will bias their portfolio choice in the direction of the aggregate portfolio choice of the community. As a result, we show that even with complete financial markets and no aggregate risk, in all stable equilibria agents hold undiversified portfolios. Moreover, if a component of community income is tied to the output of local firms, the unique equilibrium is one in which portfolio are biased towards local firms as well. In addition, we show that equilibrium Sharpe ratios can be much higher than in standard models. We conclude with a number of policy implications. ∗We are grateful to ...
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