Wednesday, April 20, 2011

IQ and Stock Market Participation

A forthcoming JoF piece from Grinblatt et al report
Stock market participation is monotonically related to IQ...High-IQ investors are more likely to hold mutual funds and larger numbers of stocks, experience lower risk, and earn higher Sharpe ratios. We discuss implications for policy and finance research.

I interpret that to mean, you need some intelligence to have the confidence to take some risk, but the smarter you are, the more you realize this game is played best at the standard CAPM level: low fees, high diversification. That is, I agree with the CAPM as a normative theory, just not a positive one; I'm just not so naive to extrapolate my very minority preferences and interpretations to 'all investors.'

Shane Frederick observed a related finding in a JEL piece where he noted that smarter people preferred greater expected choices when framed probabilistically.

I think the IQ and stock market participation finding makes sense only in the context that the stock market exists in the context of many investments with similar 'risk'. Smarter people understand you can gain an equity premium ... but only applying indices, or as an insider! Sure you can get big return otherwise--especially as a middleman--but the basic risk return payoff here is decidedly contextual.


J said...

In all IQ stanines only a minority did participate in the market. The majority of the very smartest Finns (the highest IQ stanine) avoided the market. In my opinion, this fact weakens Grinblatt's elucubrations about IQ and participation. I also wonder why he used Sharpe indices when they had actual, real portfolio yields in the annual tax declaration forms.

Anonymous said...

Money flows to where it's offered the greatest advantage. Fast readers aren't intimidated by the mind numbing complexity of financial statements and the arcane gaming rules for picking entry and exit points. People who are willing to get their hands dirty run small businesses and rental real estate, which offer better total returns but their Sharpe ratios don't look so hot due to lack of diversification. Maybe an opportunity in securitizing pools of small businesses? That would directly show the value-add of IQ (if any).