What Drives Investor's Portfolio Choices? Separating Risk Preferences from Frictions.

Join us for the last session of our in-person Financial Literacy Colloquia Fall Quarter 2024 series. Tim de Silva will present his paper, "What Drives Investor's Portfolio Choices? Separating Risk Preferences from Frictions."

What Drives Investors' Portfolio Choices? Separating Risk Preferences from Frictions
Taha Choukhmane & Tim de Silva
NBER Working Paper 32476

We study the role of risk preferences and frictions in portfolio choice using variation in 401(k) default options. Patterns of active choice in response to different default funds imply that, absent participation frictions, 94% of investors prefer holding stocks, with an equity share of retirement wealth declining with age—patterns markedly different from observed allocations. We use this quasi-experiment to estimate a life cycle model and find a relative risk aversion of 2, EIS of 0.4, and $200 portfolio adjustment cost. Our results suggest that low levels of stock market participation in retirement accounts are due to participation frictions rather than non-standard preferences such as loss aversion.