Understanding Portfolio Performance: Is Luck Very Persistent?

Abstract

We develop a parsimonious econometrics methodology to estimate individual’s portfolio return process accounting for self-selection bias from portfolio adjustment; our approach is useful to assist investors learning own return process profile. We study three components to characterize investor’s performance process: individual’s specifics, aggregate shocks, and idiosyncratic shocks. We find that individual investor returns are subject to shocks with modest persistence. Our results have implications for the calibration for the portfolio return in stochastic growth model which, in turn, have further implications for a host of other issues in financial economics such as limited stock market participation, the equity premium puzzle, and accounting for wealth inequality.