Welfare effects of information and rationality in portfolio decisions under parameter uncertainty

Abstract

We analyse and quantify, in a financial market with parameter uncertainty and for a Constant Relative Risk Aversion investor, the utility effects of two different boundedly rational (i.e. sub-optimal) investment strategies (namely, myopic and unconditional strategies) and compare them with each other and with the utility effect of full information. We show that effects are mainly caused by full information and predictability, being the effect of learning marginal. We also investigate the saver's decision regarding whether to manage her/his portfolio personally (DIY investor) or hire, against the payment of a management fee, a professional investor and find that delegation is mainly motivated by the belief that professional advisors are, depending on investment horizon and risk aversion, either better informed (‘insiders’) or more capable of gathering and processing information, rather than possessing the ability to learn from financial data. In particular, for very short investment horizons, delegation is primarily, if not exclusively, motivated by the beliefs that professional investors are better informed.