Happiness in financial decisions: Evidence from a portfolio choice model

The finance literature has also attempted to investigate and explain how human emotions can shape individuals’ financial decisions. For instance, questions that the literature has attempted to answer concern whether emotions reinforce or oppose the decision to participate in the financial market. Answers to these questions are expected to be fundamentally important for describing individuals’ preferences and for modelling investment and financial decisions in economics and finance. The mechanism underlying the role of happiness in financial decisions arises because happiness is able to alter fundamental drivers of financial behaviour, such as risk tolerance and time preferences. In this regard, economists have stressed the importance of cultural values and norms in individuals’ financial decision-making process. Specifically, the economics literature highlights the direct impact of cultural characteristics on personal attitudes and preferences, which in turn influence individuals’ financial decisions and, hence, aggregate financial-market outcomes. The contribution of this paper to the literature is that it extends the literature on happiness by explicitly considering how previous findings can be used to explain (financial) portfolio choices. From a practical viewpoint, elucidating the role of emotions in financial behavior will help improve the efficiency of policies designed to promote households’ participation in financial markets. This paper empirically investigates the role of happiness in portfolio choices. Based on micro data for a sample of five European countries, i.e., France, Germany, Italy, the Netherlands, and the U.K., spanning the period 2009-2014, the empirical results show that happiness exerts a positive effect on households’ portfolio choices, leading to higher shares of risky assets in households’ financial portfolios. The findings survive a number of robustness tests, but when asset holdings are disaggregated by asset type, the positive effect remains only for safe and low-risk assets, whereas the effect for assets with higher risks turns negative.