Portfolio choice with relative considerations and asymmetric information

Makarov, Dmitry (2007) Portfolio choice with relative considerations and asymmetric information. Doctoral thesis, University of London: London Business School.

Abstract

The primary goal of this Thesis is to contribute to the portfolio choice theory. The classical approach to portfolio choice assumes, among other things., that investors care only about their own portfolio, and also that investors have full information about the distribution of returns on the risky assets. In this Thesis, we theoretically investigate how optimal portfolio choice is affected by the presence of relative considerations and asymmetric information. It, has been widely documented in the literature that top performing mutual funds attract more new money than their less successful peers. This gives rise to relative considerations as each fund manager has incentives to outperform her peers. Chapter 2 of the Thesis investigates the optimal portfolio choice of fund managers in a setting when the number of managers is large, implying no strategic interactions. Chapter 3 addresses a similar question but in a setting with a small number of managers. The models of Chapters 2 and 3 explain several empirical findings, and also produce novel predictions which remain to be tested. Some households participate in the stock market directly, not through mutual funds. Chapter 4 of the Thesis aims at explaining some of the observed portfolio patterns of such households. We develop a theoretical model in which households possess different information about risky assets and show that the model's predictions are consistent with several empirical findings: a) non-participation of a large fraction of households, with poorer ones more likely to stay away from the stock market, b) wealth share invested into risky assets increases with wealth, c) market participation increases over time.