Expected Return Shocks and Portfolio Rebalancing

We study how an expected return shock affects households, portfolio rebalancing, and the role of financial literacy in shaping these decisions. By using Shanghai’s property tax trial in 2011, which altered the expected returns of investment properties compared to financial assets for a group of households, we examine how households adjust their portfolios in response to this shock. From 2012–2018, households impacted by the 2011 property tax trial increased their participation in the risky assets immediately and the risky asset ratio of their portfolio gradually. However, the increases in the risky asset participation and risky asset ratio only existed among households with high financial literacy. We structurally estimate a quantitative life-cycle model with heterogeneity to match the group-specific moments and response functions, and find that households with low financial literacy on average bear a fixed entry cost of approximately $4,864 compared to $1,706 of households with high financial literacy, and that the expected excess return of financial risky assets for the low financial literacy group is on average 3.9% compared to 6.6% for the high financial literacy group.