What Drives Variation in Investor Portfolios? Estimating the Roles of Beliefs and Risk Preferences

We present a portfolio choice demand model that allows for the nonparametric estimation of investors’ (subjective) expectations and risk preferences. Utilizing a comprehensive dataset of 401(k) plans from 2009 through 2019, we explore heterogeneity in asset allocations across plans using our empirical framework. This framework enables us to recover investors’ beliefs about each asset and examine the implications and potential sources of those beliefs. Our estimates suggest that heterogeneity in expectations across investors accounts for twice as much variation in portfolio holdings as heterogeneity in risk aversion. Belief heterogeneity is driven in part by the idiosyncratic characteristics and experiences of investors, reflecting local sources of information such as county-level GDP and employers’ past performance. Our findings suggest that, to the extent it is distortive, belief heterogeneity imposes modest costs on the median investor in terms of foregone annual returns, though the costs for the upper quartile are significant.