Siegel and Thaler have an excellent non-technical article in the Winter 1997
Journal of Economic Perspectives on the Equity Premium Puzzle.
Those who have had my graduate course will have little trouble
understanding the utility function issues in this article, while those
who have not might want to take a look at
the Life Cycle Savings article in the 1995 issue of Financial Counseling
and Planning (full article on the FCP web site), and
Fan, X.J., Chang, Y.R. & Hanna, S. (1993). Real income growth and optimal credit,
Financial Services Review, 3(1), 45-58.
Siegel and Thaler discuss various explanations as to why stocks have such
a high rate of return, and finally turn their attention to my favorite
explanation — that many people are not behaving in an informed, rational
manner in making their investment decisions.
(I believe that they do not adequately discuss liquidity constraints facing many
households, but there are also many households who have adequate liquidity
who do not put enough of their long-term investments in stocks.)
You can construct a behavioral model explaining some
individual investor decisions, but does that mean it is
a good normative model for prescription and education?
My preferred alternative is a rational model, with lack of information
and limited rationality among some agents. For instance, if empirically,
we find that all other things equal, less educated consumers
are much less likely to hold stocks** than more educated consumers,
my interpretation is not that less educated consumers are
more risk averse*, but rather, that less educated consumers
are making worse decisions because of lack of information
and lack of ability to process the information presented to them.
*The differences would imply very large differences
in risk aversion by education.
**Similarly, I think we should be cautious in inferences about
reported risk tolerance differences — see Sung and Hanna’s article in the 1996 issue of Financial Counseling and Planning
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