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Intertemporal consumption choices, transaction costs and limited participation in financial markets: reconciling data and theory

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  • Orazio P. Attanasio
  • Monica Paiella

Abstract

This paper builds a unifying framework based on the theory of intertemporal consumption choices that brings together the limited participation-based explanation of the Consumption Capital Asset Pricing Model's poor empirical performance and the transaction costs‐based explanation of incomplete portfolios. Using the implications of the consumption model and observed household consumption and portfolio choices, we identify the preference parameters of interest and a lower bound for the costs rationalizing non‐participation in financial markets. Using the US Consumer Expenditure Survey and assuming isoelastic preferences, we estimate the coefficient of relative risk aversion at 1.7 and a cost bound of 0.4% of non‐durable consumption. Our estimate of the preference parameter is theoretically plausible and the bound sufficiently small to be likely to be exceeded by the actual total (observable and unobservable) costs of participating in financial markets. Copyright (C) 2010 John Wiley & Sons, Ltd.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 26 (2011)
Issue (Month): 2 (March)
Pages: 322-343

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Handle: RePEc:wly:japmet:v:26:y:2011:i:2:p:322-343

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  1. Orazio Attanasio & James Banks & Sarah Tanner, 1998. "Asset Holding and Consumption Volatility," NBER Working Papers 6567, National Bureau of Economic Research, Inc.
  2. Attanasio, Orazio P & Weber, Guglielmo, 1989. "Intertemporal Substitution, Risk Aversion and the Euler Equation for Consumption," Economic Journal, Royal Economic Society, vol. 99(395), pages 59-73, Supplemen.
  3. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-62, April.
  4. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  5. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
  6. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  7. Samuelson, Paul A, 1969. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 239-46, August.
  8. Gomes, Francisco J & Michaelides, Alexander, 2007. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," CEPR Discussion Papers 6136, C.E.P.R. Discussion Papers.
  9. Gomes, Francisco J & Michaelides, Alexander, 2005. "Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence," CEPR Discussion Papers 4853, C.E.P.R. Discussion Papers.
  10. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  11. Luttmer, Erzo G J, 1996. "Asset Pricing in Economies with Frictions," Econometrica, Econometric Society, vol. 64(6), pages 1439-67, November.
  12. Monica Paiella, 2004. "Heterogeneity in Financial Market Participation: Appraising its Implications for the C-CAPM," Review of Finance, Springer, vol. 8(3), pages 445-480.
  13. Monica Paiella, 2006. "The Foregone Gains of Incomplete Portfolios," CSEF Working Papers 156, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  14. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
  15. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
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Cited by:
  1. Khorunzhina, Natalia, 2013. "Structural estimation of stock market participation costs," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2928-2942.
  2. Guiso, Luigi & Sodini, Paolo, 2012. "Household Finance: An Emerging Field," CEPR Discussion Papers 8934, C.E.P.R. Discussion Papers.
  3. Sara LaLumia & James Sallee, 2011. "The Value of Honesty: Empirical Estimates from the Case of the Missing Children," Department of Economics Working Papers 2011-05, Department of Economics, Williams College.
  4. Neven Vidakovic, 2007. "The Impact Of The Choice Of Monetary Policyon Households," Montenegrin Journal of Economics, Economic Laboratory for Transition Research (ELIT), vol. 3(6), pages 109-120.
  5. Jack Favilukis, 2007. "Inequality, stock market participation, and the equity premium," LSE Research Online Documents on Economics 24500, London School of Economics and Political Science, LSE Library.
  6. Sheng Guo, 2009. "Switching Regression Estimates of EIS for Stockholders and Non-Stockholders," Working Papers 0903, Florida International University, Department of Economics.
  7. Alessandro Bucciol, 2006. "The Roles of Temptation and Social Security in Explaining Individual Behavior," "Marco Fanno" Working Papers 0032, Dipartimento di Scienze Economiche "Marco Fanno".
  8. Christensen, Peter Ove & Larsen, Kasper & Munk, Claus, 2012. "Equilibrium in securities markets with heterogeneous investors and unspanned income risk," Journal of Economic Theory, Elsevier, vol. 147(3), pages 1035-1063.

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