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  5. Asset Pricing: Portfolio Choice and Asset Allocation
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Asset Pricing: Portfolio Choice and Asset Allocation

Paper Session

Saturday, Jan. 7, 2023 10:15 AM - 12:15 PM (CST)

Sheraton New Orleans, Borgne
Hosted By: American Finance Association
  • Chair: Konstantin Milbradt, Northwestern University

What Drives Investors’ Portfolio Choices? Separating Risk Preferences from Frictions

Taha Choukhmane
,
Massachusetts Institute of Technology
Tim de Silva
,
Massachusetts Institute of Technology

Abstract

We study the role of risk preferences and frictions in portfolio choice, using variation in the default asset allocation of 401(k) plans. We estimate that, absent participation frictions, 94% of investors would prefer holding stocks in their retirement accounts, with an equity share of retirement wealth that declines with age—patterns markedly different from their observed allocations. We use this variation to estimate a structural life cycle portfolio choice model, finding evidence consistent with relative risk aversion of 2.1 and a portfolio adjustment cost of around $200. Our results suggest that the lack of participation in the stock market is mainly due to participation frictions rather than non-standard preferences such as loss-aversion.

Optimal Allocation to Private Equity

Nicola Giommetti
,
Copenhagen Business School
Morten Sorensen
,
Dartmouth College

Abstract

We study the portfolio problem of an investor (LP) that invests in stocks, bonds, and private equity (PE) funds. The LP repeatedly commits capital to PE funds. This capital is only gradually contributed and eventually distributed back to the LP, requiring the LP to hold a liquidity buffer for its uncalled commitments. Despite being riskier, PE investments are not monotonically declining in risk aversion. Instead, there are two qualitatively different investment strategies with intuitive heuristics. We introduce a secondary market for PE partnership interests to study optimal trading in this market and implications for the LP’s optimal investments.

Capital Commitment

Elise Gourier
,
Essec Business School
Ludovic Phalippou
,
Oxford University
Mark Westerfield
,
University of Washington

Abstract

Twelve trillion dollars are allocated to private market funds that require outside investors to commit to transferring capital on demand. We show within a novel dynamic portfolio allocation model that ex-ante commitment has large effects on investors’ portfolios and welfare, and we quantify those effects. Investors are under-allocated to private market funds and are willing to pay a larger premium to adjust the quantity committed than to eliminate other frictions, like timing uncertainty and limited tradability. Perhaps counter-intuitively, commitment risk premiums increase with secondary market liquidity and they do not disappear even if investments are spread over many funds.

Discussant(s)
Geoffery Zheng
,
New York University-Shanghai
Dan Luo
,
University of Chicago
Simon Mayer
,
University of Chicago
JEL Classifications
  • G1 - Asset Markets and Pricing