Week 7 - Calvet, L. E., Campbell, J. Y., and Sodini, P. (2009). Measuring the financial sophistication of households

Question 1

What is the main idea of this paper?

Answer 1

• Typical investment mistakes:
  o Insufficient diversification
  o Naïve diversification
  o Excessive trading
  o Inertia
  o Disposition (selling) effect
  o Attention (buying) effect
• Financial sophistication means the avoidance of the abovementioned mistakes
• Relate three investment mistakes of households to household characteristics and construct a joint index of
  financial sophistication.

Question 2

What are the findings?

Answer 2

• The model
  o Under diversification: Sharpe ratio loss (difference to unhedged global equity sharpe ratio)
  o Inertia: changes in percentage allocation to risky assets
  o Disposition effects: realized stock gains vs. losses
• Financial wealth has strongest negative effect on each investment mistake
• Does a particular combination of HH characteristics lead to more sophisticated behavior, i.e., lower levels of
  all three mistakes?
  o Sophisticated HHs have higher financial wealth, education and size.

Question 3

What are the conclusions?

Answer 3

• The index increases with financial wealth and HH size, and to a lesser extent with education and financial experience
• The index is lower for self-employed and immigrant households