Theory of Social Returns in Portfolio Choice with Application to Microfinance

This paper focuses on the theoretical fundamentals and practical implications of social returns.

It distinguishes between two main setups, one where social returns are taken as stochastic, and another where they are deterministic. The study applies each version of the theoretical model to a different realm. In the deterministic setup, it looks at an investor who faces a small number of assets and assigns a social return only to the microfinance investment fund (MIV) in its portfolio. In the second application with stochastic social returns, the study estimates statistical moments of social returns of various MFIs and looks at how MIVs should allocate funds to MFIs.

The study emphasizes the difficulty of measuring social returns. It also highlights the importance of including initial wealth of the investor, stating that:

• Simply using absolute wealth levels instead of returns in the objective function leads to unrealistic results;
• Increase in wealth would increase risk aversion in a mean-variance setup;
• Consideration of wealth effects becomes more important once social returns are taken into account;
• Higher wealth implies less risk aversion and more social concern.