Harjoat Singh Bhamra, Raman Uppal, 18 October 2018

Most households do not diversify but instead invest in only a handful of stocks, typically ones with which they are familiar. Using a new framework for evaluating the welfare losses from this underdiversification, this column argues that when the effect of familiarity biases on a household’s decision to allocate wealth between risky and safe assets and on its consumption-savings decisions are taken into account, the welfare loss is amplified by a factor of four. The impact on household and social welfare of financial policies through innovation, education, and regulation could thus be substantial.

CEPR Policy Research