Diversification, gambling and market forces

Diversification, gambling and market forces Though simple and appealing, mean-variance portfolio choice theory does not describe actual diversification choices by investors, especially their propensity to gamble and the solvency constraints they face. Using 8 million trades realized by 90,000 individual investors, we show that diversification choices are in fact strongly driven by the skewness of returns, especially in bull markets, but also by the amount to be invested in risky assets. Increasing this amount by 10 % leads to increase by 3.8 % the number of stocks in investors’ portfolios, controlling for portfolio skewness. An important contribution of this paper is to show that the strength of the relationship between diversification and the skewness of returns is shaped by market forces. A strong negative relationship exists in bull markets but disappears in bear markets, a result not found in the literature. Our results survive several robustness checks, including controlling for individual heterogeneity and time-variability of stock price co-movements. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

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Publisher
Springer US
Copyright
Copyright © 2015 by Springer Science+Business Media New York
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-015-0497-1
Publisher site
See Article on Publisher Site

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