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How Much Can Asset Portfolios of Rural 
Households Benefit from Formal Financial 
Services? 
Vishnu Prasad & Rachit Khaita...
Section 1 
• Conceptual framework 
Section 2 
• Extant asset portfolios 
Section 3 
• Asset portfolios with the 
introduct...
Section 1 
Conceptual Framework
Modern Portfolio Theory 
“Not only does the E-V [expected returns-variance of returns] hypothesis 
imply diversification, ...
Efficient Frontier 
25.00% 
20.00% 
15.00% 
10.00% 
5.00% 
0.00% 
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 
Efficien...
Efficient Frontier 
30.0% 
25.0% 
20.0% 
15.0% 
10.0% 
5.0% 
0.0% 
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 
Efficien...
How do you answer this question? 
We construct 
stylised household 
asset portfolios that 
are stratified based 
on source...
Section 2 
Extant Asset Portfolios
Household Finance Perspective 
Households face long but finite planning 
horizons 
Household asset portfolios are typicall...
Household Finance Perspective 
There are discrepancies between ideal and observed 
financial behaviour of households 
Inve...
Dataset 
1,43,632 
customers 
201 branches 
5 districts 
in Tamil Nadu, 
Uttarakhand, and 
Odisha
Stylised Asset Portfolios 
Asset Category Median Value (in INR) Percentage of Total Assets 
Electronics 7,000 3% 
House 99...
Occupational Classification 
51% 
15% 
Primary occupation 56% 
13% 
12% 
6% 
2% 1% 1% 0% 
19% 
Secondary occupation 
15% 
...
Household Typologies 
Jewellery 
Jewellery 
Jewellery 
Jewellery 
Jewellery 
Land 
Land 
Land 
Land 
Land 
Livestock 
Live...
Portfolio Risk-Return on Physical Assets: 
Estimation Methodology 
Land Rs. 14,535 output per acre of a basket of 44 crops...
Portfolio Risk-Return on Physical Assets: 
Estimation Methodology 
Livestock Revenue streams- Milk, Manure & Calf 
Costs- ...
Risk-Returns of Physical Assets 
Jewellery (Gold) Land Livestock 
Annual 
Returns 14.64% 2.35% 10.26% 
Standard 
Deviation...
Portfolio Risk-Return on Physical Assets 
6.93% 
14.62% 
6.86% 
7.64% 
7.07% 
6.13% 
18.60% 
5.48% 
6.79% 
5.92% 
20% 
18%...
Section 3 
Introduction of Financial Assets
Risk-Return of Physical Assets (with insurance) 
Land Livestock 
Annual Returns 2.52% 12.06% 
Change in Returns 0.17% 1.80...
Portfolio Risk-Return (with insurance)
Suite of Replacement Financial Assets 
Return Risk 
BSE Top 100 22.82% 33.24% 
Equity-ETF 20.77% 30.43% 
Savings Bank Acco...
Effect of Replacement Financial Assets 
Agriculture- 
Only 
Labour- 
Only 
Salaried- 
Agriculture 
Business- 
Agriculture ...
Efficiency Frontier: Replacement Financial Assets
Efficiency Frontier: Replacement Financial Assets 
with NPS
Policy Implications 
Products 
• Mutual Funds 
• National Pension Scheme – Swavalamban (NPS-S) 
Distribution 
Channels 
• ...
Conclusion 
Modern finance is a central pillar of 
civilised society, and for society to fully 
realise its promise, finan...
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How much can asset portfolios of rural households benefit from formal financial services?

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Vishnu Prasad & Rachit Khaitan talk about their research paper “How much can asset portfolios of rural households benefit from formal financial services?” This paper is a systematic attempt to quantify the benefits of financial inclusion and capital markets access using tools of modern finance.

Published in: Economy & Finance
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How much can asset portfolios of rural households benefit from formal financial services?

  1. 1. How Much Can Asset Portfolios of Rural Households Benefit from Formal Financial Services? Vishnu Prasad & Rachit Khaitan October 15th, 2014
  2. 2. Section 1 • Conceptual framework Section 2 • Extant asset portfolios Section 3 • Asset portfolios with the introduction of financial assets Agenda
  3. 3. Section 1 Conceptual Framework
  4. 4. Modern Portfolio Theory “Not only does the E-V [expected returns-variance of returns] hypothesis imply diversification, it implies the “right kind” of diversification for the “right reason.” The adequacy of diversification is not thought by investors to depend solely on the number of different securities held. A portfolio with sixty different railway securities, for example, would not be as well diversified as the same size portfolio with some railroad, some public utility, mining, various sorts of manufacturing, etc. The reason is that it is generally more likely for firms within the same industry to do poorly at the same time than for firms in dissimilar industries.” (Markowitz, 1952)
  5. 5. Efficient Frontier 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% Efficient Frontier Return Risk Asset A 20% 28% Risk Free Asset 8% 0% Weight A Weight Rf Portreturn PortSD -50% 150% 2.00% 14.00% -40% 140% 3.20% 11.20% -30% 130% 4.40% 8.40% -20% 120% 5.60% 5.60% -10% 110% 6.80% 2.80% 0% 100% 8.00% 0.00% 10% 90% 9.20% 2.80% 20% 80% 10.40% 5.60% 30% 70% 11.60% 8.40% 40% 60% 12.80% 11.20% 50% 50% 14.00% 14.00% 60% 40% 15.20% 16.80% 70% 30% 16.40% 19.60% 80% 20% 17.60% 22.40% 90% 10% 18.80% 25.20% 100% 0% 20.00% 28.00%
  6. 6. Efficient Frontier 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% Efficient Frontier 2 Assets Efficient Frontier 3 Assets Return Risk Asset A 20% 28% Asset B 25% 33% Correlation 37.00% W Asset AW Asset B Portreturn PortSD 0% 100% 25.0% 33.0% 10% 90% 24.5% 30.8% 20% 80% 24.0% 28.9% 30% 70% 23.5% 27.3% 40% 60% 23.0% 26.1% 50% 50% 22.5% 25.3% 60% 40% 22.0% 24.9% 70% 30% 21.5% 25.0% 80% 20% 21.0% 25.6% 90% 10% 20.5% 26.6% 100% 0% 20.0% 28.0%
  7. 7. How do you answer this question? We construct stylised household asset portfolios that are stratified based on source of income (primary and secondary). Using Modern Portfolio Theory (MPT), we then compare the performance of the stylised portfolios over time with the performance of a hypothetical portfolio that offers these households access to a suite of financial instruments. Finally, we quantify the financial gain to five stylised occupational categories from a limited suite of seven financial assets.
  8. 8. Section 2 Extant Asset Portfolios
  9. 9. Household Finance Perspective Households face long but finite planning horizons Household asset portfolios are typically composed of non-tradeable and illiquid assets such as housing and human capital Households often face significant constraints on borrowing
  10. 10. Household Finance Perspective There are discrepancies between ideal and observed financial behaviour of households Investment in housing crowds out investment in financial assets Household asset portfolios are diverse, simple, and predominantly invested in low-risk assets Households actively manage their asset portfolios, even in the absence of access to formal financial markets
  11. 11. Dataset 1,43,632 customers 201 branches 5 districts in Tamil Nadu, Uttarakhand, and Odisha
  12. 12. Stylised Asset Portfolios Asset Category Median Value (in INR) Percentage of Total Assets Electronics 7,000 3% House 99,000 49% Vehicle 1,250 0.6% Consumption assets (total) 107,250 53% Agricultural equipment 500 0.25% Investment - 0% Jewellery 88,320 44% Land - 0% Livestock 4,500 2% Shop - 0% Investment assets (total) 93,320 46% All assets (total) 200,570 100%
  13. 13. Occupational Classification 51% 15% Primary occupation 56% 13% 12% 6% 2% 1% 1% 0% 19% Secondary occupation 15% 5% 3% 1% 1% 1% 0%
  14. 14. Household Typologies Jewellery Jewellery Jewellery Jewellery Jewellery Land Land Land Land Land Livestock Livestock Livestock Livestock 600,000 500,000 400,000 300,000 200,000 100,000 0 Agriculture-Only Labour-Only Salaried-Agriculture Business-Agriculture Labour-Agriculture Median Value (INR) Consumption assets Agricultural-equipment Investment Jewellery Land Livestock Shop
  15. 15. Portfolio Risk-Return on Physical Assets: Estimation Methodology Land Rs. 14,535 output per acre of a basket of 44 crops for 17 states in India Income per acre is 20-35% of the value of the output Source of risk - 1% deviation from mean historical rainfall leads to a 1% decline in output Drought or Flood event - If rainfall varies in excess of one standard deviation above or below mean rainfall Hold for a 50-year period
  16. 16. Portfolio Risk-Return on Physical Assets: Estimation Methodology Livestock Revenue streams- Milk, Manure & Calf Costs- Purchase price, Fodder, Medical expenses & Insemination Purchase price of the cow- Rs. 20,000 (Ongole breed) Assumed life expectancy- 10 years Sources of risk - (1) Morbidity (incidence of foot and mouth disease; (2) Mortality (death of the animal during its 10-year lifetime) Mortality and morbidity rates- Primary research conducted by Bangar et al. (2013)
  17. 17. Risk-Returns of Physical Assets Jewellery (Gold) Land Livestock Annual Returns 14.64% 2.35% 10.26% Standard Deviation 18.70% 0.21% 17.86%
  18. 18. Portfolio Risk-Return on Physical Assets 6.93% 14.62% 6.86% 7.64% 7.07% 6.13% 18.60% 5.48% 6.79% 5.92% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Agriculture-Only Labour-Only Salaried-Agriculture Business-Agriculture Labour-Agriculture Annual Return Standard Deviation
  19. 19. Section 3 Introduction of Financial Assets
  20. 20. Risk-Return of Physical Assets (with insurance) Land Livestock Annual Returns 2.52% 12.06% Change in Returns 0.17% 1.80% Standard Deviation 0.00% 9.12% Change in Risk -0.21% -8.74%
  21. 21. Portfolio Risk-Return (with insurance)
  22. 22. Suite of Replacement Financial Assets Return Risk BSE Top 100 22.82% 33.24% Equity-ETF 20.77% 30.43% Savings Bank Account 5.00% 0.00% G-Sec (3 year) 7.17% 0.98% G-Sec (9 year) 7.61% 0.79% G-Sec (15 year) 7.97% 0.70%
  23. 23. Effect of Replacement Financial Assets Agriculture- Only Labour- Only Salaried- Agriculture Business- Agriculture Labour- Agriculture Nominal Returns on Portfolio of Physical Assets 6.93% 14.62% 6.86% 7.64% 7.07% Real Returns on Portfolio of Physical Assets -1.11% 6.58% -1.18% -0.40% -0.97% Real Returns on Portfolio of Financial Assets 2.50% 8.60% 2.01% 3.05% 2.34% Change in Returns 3.61% 2.02% 3.19% 3.45% 3.31% Standard Deviation 6.13% 18.60% 5.48% 6.79% 5.92%
  24. 24. Efficiency Frontier: Replacement Financial Assets
  25. 25. Efficiency Frontier: Replacement Financial Assets with NPS
  26. 26. Policy Implications Products • Mutual Funds • National Pension Scheme – Swavalamban (NPS-S) Distribution Channels • Banking designs • Economies of scope • KYC norms • Small-ticket transactions • Universal bank accounts
  27. 27. Conclusion Modern finance is a central pillar of civilised society, and for society to fully realise its promise, finance “has to be expanded, democratized and humanized…by giving people the ability to participate in the financial system as equals.” - Robert J. Shiller, Finance and the Good Society

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