Wishful Investing

The May American Economic Review explains how six investment puzzles can be explained if investors allow themselves a limited degree of wishful thinking: 

Human beings want to believe that good outcomes [for them] in the future are more likely, but also want to make good decisions that increase average outcomes in the future. We consider a general equilibrium model with complete markets and show that when investors hold beliefs that optimally balance these two incentives, portfolio holdings and asset prices match six observed patterns: (i) … investors … are not perfectly diversified … (ii) … the utility cost of the lack of diversification are limited; (iii) … investors over-invest in only one … security … (iv) … optimal portfolios of ex ante identical investors can be heterogeneous; (v) … investors tend to overinvest in the most skewed securities; (vi) … more skewed asset can have lower average returns.

Can you admit to yourself that you lose on your investments in order to let yourself believe that you will win on them?  If not, stop fitting these patterns! 

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