PERSONAL FINANCE

Personal finance (also known as household finance) asks how households actually invest, and how they should invest. It tackles the issues of participation in financial markets and portfolio diversification, as well as the consumption/saving decision. It further investigates financial investment issues that are particularly relevant for individuals or households: housing and mortgage decisions, consumer credit, and investment in private pensions.

Two thirds of the course will be devoted to the standard model, where individuals maximize expected life-time utility subject to a number of constraints. Transaction costs and information asymmetries are typically considered as possible explanations of why households do not invest according to textbook prescriptions. Important explanations that have recently been explored include low financial literacy and lack of trust.

The other third of the course will instead introduce an alternative approach, known as behavioural finance. Behavioural finance builds upon some descriptive models for decision making under risk recently developed by psychologists, focusing on prospect theory, cumulative prospect theory and on the concepts of loss aversion, probability distortion, and mental accounting.
This part of the course will provide a description of market anomalies and inefficiencies, and discuss some psychological biases and limits of real investors that might generate those anomalies. It will then present behavioural models for portfolio selection that can explain these anomalies, also discussing how they can be integrated into the advisory process of banks.