How Suboptimal are Linear Sharing Rules?

Bjarne Astrup Jensen, Jørgen Aase Nielsen

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Abstract

The objective of this paper is to analyze criteria for portfolio choice when two investors are forced to invest in a common portfolio and share the proceeds by a linear sharing rule. A similar situation with many investors is typical for defined contribution pension schemes. The restriction implies two sources of suboptimal investment decisions as seen from each of the two investors individually. One is the suboptimal choice of portfolio, the other is the forced linear sharing rule. We measure the combined consequence for each investor by their respective loss in wealth equivalent. We show that significant losses can arise when investors are diverse in their risk attitude. We also show that an investor with a low degree of risk aversion, like the logarithmic or the square root investor, often applied in portfolio choice models, can either inflict or be subject to severe losses when being forced to participate in such a common investment pool.
Original languageEnglish
JournalAnnals of Finance
Volume12
Issue number2
Pages (from-to)221–243
Number of pages23
ISSN1614-2446
DOIs
Publication statusPublished - May 2016

Keywords

  • Constrained portfolio choice
  • Pareto optimal sharing rules
  • Suboptimal sharing rules
  • Linear sharing rules

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