ARE U.S. HOUSEHOLD PORTFOLIOS EFFICIENT?
Presented in Partial Fulfillment of the Requirements for
Degree Doctor of Philosophy in the Graduate
School of The Ohio State University
Whuei-wen Lai, M.B.A.
The Ohio State University
Copyright by Whuei-wen Lai, 2003
The theoretical mean-variance efficient portfolio model was modified to
incorporate human wealth and net primary residence. Eight traded assets
were selected to represent the set of risky assets available to the household
investors: combined stock index, large stocks, small stocks, the average
return series for individual stocks in the CRSP Decile 10 (smallest) stock
portfolio to proxy business ownerships, corporate bonds, long-term government
bonds, intermediate government bonds, and Ibbotson Associate’s real estate
return series. Treasury bill represents the risk-free rate in this study.
Simulation programs were developed to identify the efficient portfolios
by finding the portfolio weights in risky assets that result in the minimum-variance
frontier for the total portfolio. The results of the simulation programs
give the efficient asset allocations to different household investors with
different human wealth ratios, net primary residence ratios, and planned
investment horizons, once the diversification of investment portfolios are
related to the perceived stability of future employment income.
The simulation results show that when rational household investors have
a high human wealth ratio (e.g., those with ages between 30 to 40 years old),
and a long investment time horizon (e.g., 15 year before their retirement),
their efficient frontier is a combination of intermediate government bond,
real estate, large stocks, small stocks and business ownerships. People
with high-risk aversion should invest in intermediate government bonds and
real estate for a 15 year horizon. People with low risk aversion should invest
in real estate, small stock funds, and business ownerships for a 15 year
horizon. People who have risk aversion between these two points should choose
a combination in the order of intermediate government bonds, real estate,
large stocks, small stocks, and business ownerships. People with higher
ages have similar combination in their efficient frontiers.
The efficient portfolios from the simulation results are compared to the
current portfolios of U.S. households estimated from the 1998 Survey of Consumer
In the formal efficiency test of households’ current portfolios, about one-third
of total households hold inefficient mean-variance portfolios, compared with
the same characteristics as those used to produce the simulation results
in this study.