Portfolio underdiversification is one of the most costly losses accumulated over a household’s life cycle. We provide new evidence on the impact of financial inclusion services on households’ portfolio choice and investment efficiency using 2015, 2017, and 2019 survey data for Chinese households. We hypothesize that higher financial inclusion penetration encourages households to participate in the financial market, leading to better portfolio diversification and investment efficiency. The results of the baseline model are consistent with our proposed hypothesis that higher accessibility to financial inclusion encourages households to invest in risky assets and increases investment efficiency. We further estimate a dynamic double machine learning model to quantitatively investigate the non-linear causal effects and track the dynamic change of those effects over time. We observe that the marginal effect increases over time, and those effects are more pronounced among low-asset, less-educated households and those located in non-rural areas, except for investment efficiency for high-asset households.

We study the effects of mortgage debt and informal home loans on stock ownership. Mortgage debt is typically originated with licensed financial institutions while informal home loans are obtained from private lending. Using the China Household Finance Survey data, we show that mortgage debt has a positive relationship, while informal home loans have a negative relationship, with a household’s likelihood and degree of subsequent stock market participation. Instrumental variable estimates identify a causal impact of these effects. Further tests demonstrate cross-sectional variations of these effects across urban development, education, financial literacy, loan interest rate, maturity, and funding sources.

Research into asset pricing anomalies in the China A-share market is hampered given the short time series of available returns. Even when average excess returns on candidate factor portfolios are economically sizeable, conventional portfolio sorting methods lack statistical power. We apply an efficient sorting procedure that combines firm characteristics with the covariance matrix. For the China A-share market, we find that the efficient sorting procedure doubles the t-statistics compared to conventional portfolio sorts, leading to nine instead of three significant anomalies over the postreform period from 2008 to 2020. We find significant size, value, low-risk, and returns-based anomalies. While portfolio characteristics differ between sorting methods, we find that efficient sorting portfolios highly correlate with equally weighted portfolios and capture the same underlying anomaly.

Using unique survey data from the China Household Finance Survey, we estimate the extent of “narrow framing”, which is a widely documented behavioral bias, among Chinese households, using their portfolio choices. Conditional on stock market participation, we find that most Chinese households exhibit significant narrow framing. Based on the obtained estimates, we show that narrow framing positively predicts the extent of under diversification. Most importantly, we argue that narrow framing is an irreplaceable of understanding households’ portfolio choices, even after considering measurement error and a wide set of indicators of diversification

This paper investigates the impact of background risk on an investor’s portfolio choice in a mean–variance framework, and analyzes the properties of efficient portfolios as well as the investor’s hedging behavior in the presence of background risk. Our model implies that the efficient portfolio with background risk can be separated into two independent components: the traditional mean–variance efficient portfolio and a self-financing component constructed to hedge against background risk. Our analysis also shows that the presence of background risk shifts the efficient frontier of financial assets to the right with no changes in its shape. Moreover, both the composition of the hedge portfolio and the location of the efficient frontier are greatly affected by a number of background risk factors, including the proportion of background assets in total wealth and the correlation between background risk and financial risk.

This paper investigates the impacts of background risk on investors’ portfolio choice in a mean-variance framework and analyzes the properties of the selected portfolio and investors’ hedging behaviour. Our model implies that the optimal portfolio with background risk can be separated into two independent components: the traditional mean-variance optimal portfolio and the self-financing portfolio constructed to hedge against background risk. Our results show that both the composition and risk of the optimal portfolio are greatly affected by a number of background risk factors, including the quantity and risk of the assets that are exposed to background risk, as well as the correlation between background assets and those in the portfolio.

This paper studies sequential portfolio choices by MPS-risk-averse investors in a continuous time jump-diffusion framework. It is shown that the optimal trading strategies for MPS risk averse investors, if they exist, must be located on a so-called `temporal efficient frontier' (t.e.f.). The t.e.f. is found not to coincide with the local instantaneous frontier --- the continuous time analogue of Markowitz's mean-variance frontier. This observation is potentially useful in understanding the existence of documented financial anormally in empirical finance --- MPS risk averse investors may not wish to invest along the local instantaneous Markowitz's mean-variance frontier, but instead hold portfolios on the t.e.f.. The optimal portfolio on the t.e.f. could well fall strictly within the instantaneous local Markowitz's efficient frontier. Our observations on mutual fund separation are also profound and interesting. In contrast to the classical two-fund separation along the line of Black (1972) and Tobin (1958), our study shows that MPS-risk-averse investors' optimal trading strategy is target rate specific. Precisely, investors with different target rates may end up investing into different managed mutual funds, each involving a specific set of separating portfolios. Our theoretic findings are, nevertheless, much in line with the real world phenomena on the existence of various types of mutual funds offered by different financial institutes, each aiming to attract demand from some specific groups of investors --- a picture that is in sharp contrast to the theoretical prediction made by Black (1972) and Tobin (1958). Finally, our study sheds light on the difference between expected utility and MPS-risk-averse investors concerning their trading behavior in sequential time frame. Even though these two groups of investors may end up holding a common risky portfolio in each spot market, the differences between their trading behaviors are most reflected through the portfolio weights assigned to each of the separating portfolios within the time frame and across states. Precisely, the portfolio weights corresponding to investors respectively from the two groups are associated with recognizable different time patterns. We showed that such difference in trading behavior would be also reflected from the time patterns of the instantaneous returns and the volatilities of the funds respectively managed by investors from these two groups.

Price and quantity are the two fundamental variables in the analysis of market interactions. Yet the study of financial markets has focused primarily on the behavior of asset prices and their relation to economic fundamentals. Much less attention has been devoted to the understanding of quantities such as trading volume. Only recently, there has been a growing body of work to link price {\it and} volume to economic fundamentals. In this paper, I review some of these work within a unified framework. I start by describing an intertemporal asset pricing model that explicitly models investors' trading motives, their optimal portfolio choices and the resulting equilibrium asset prices. I then examine the price-volume implications within the framework of the model. Finally, I discuss the results from the empirical analysis of volume and stock returns based on the data of the U.S. stock market. The theoretical analysis together with its empirical support clearly demonstrate that volume and prices are jointly linked to the economic fundamentals, e.g., the risks of the assets and the investors' attitude toward them. Moreover, the behavior of volume is closely related to the behavior of prices and from which we can learn a great deal about the prices as well as the economic fundamentals.

Much recent work has documented evidence for predictability of asset returns.We show how such predictability can affect the portfolio choice of long-lived investors who value wealth not for its own sake but for the consumption their wealth can support.We develop an approximate solution method for the optimal consumption and portfolio choice problem of an infinitely-lived investor with Epstein-Zin utility who faces a set of asset returns described by a vector autoregression in returns and state variables.Empirical estimates in long-run annual and postwar quarterly US data suggest that the predictability of stock returns greatly inceases the optimal demand for stocks.The role of nominal bonds in long-term portfolios depends on the importance of real interest rate risk relative to other sources of risk.We extend the analysis to consider long-term inflation-indexed bonds and find that these bonds greatly increase the utility of conservative investors,who should hold large positions when they are available.

We investigate the optimal dynamic consumption, housing and portfolio decisions for an investor who receives stochastic labor income and acquires housing services from either renting or owning a house. We find that the investor prefers owning to renting to take advantage of lower owning cost when not liquidity?constrained. More important, when indi®erent between owning and renting, the homeowner holds a higher equity proportion in his liquid financial portfolio (bond and stock), yet a lower equity proportion in his total financial wealth (stock, bond and home equity) than the renter. Further, having the opportunity to own a house tilts a renter’s portfolio towards safe asset, while being able to rent housing services induces a homeowner to increase his stock holding. Denying investors access to either the house owning or rental market can lead to large welfare costs. Empirical evidence from the 1998 Survey of Consumer Finance data is broadly consistent with our theoretical predictions.