NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

An Asset Allocation Puzzle

Niko Canner, N. Gregory Mankiw, David N. Weil

NBER Working Paper No. 4857
Issued in September 1994
NBER Program(s):   AP   ME

This paper examines popular advice on portfolio allocation among cash, bonds, and stocks. It documents that this advice is inconsistent with the mutual-fund separation theorem, which states that all investors should hold the same composition of risky assets. In contrast to the theorem, popular advisors recommend that aggressive investors hold a lower ratio of bonds to stocks than conservative investors. The paper explores various possible explanations of this puzzle. It concludes that the portfolio recommendations can be explained if popular advisors base their advice on the unconditional distribution of nominal returns. It also finds that the cost of this money illusion is small, as measured by the distance of the recommended portfolios from the mean-variance efficient frontier.

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Document Object Identifier (DOI): 10.3386/w4857

Published: American Economic Review, Vol. 87 (March 1997): 181-191.

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