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Limited Financial Market Participation: A Transaction Cost-Based Explanation

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Author Info
Monica Paiella () (Bank of Italy, Research Department)

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Abstract

This paper focuses on the issue of limited financial market participation and determines a lower bound on the level of fixed transaction costs that are required to reconcile observed portfolio choices with asset returns within an isoelastic utility framework. The bound is determined from the set of conditions that ensure the optimality of consumption behavior by financial market non-participants. It represents the lowest possible cost rationalizing observed non-participation choices by providing a measure of the forgone utility gains from participation for observed non-participants. Such gains are related both to the magnitude of financial market returns and to the opportunity of smoothing consumption, with the benefits of the former decreasing in the degree of relative risk aversion and those of the latter increasing in it. Using the US Consumer Expenditure Survey, I find that a yearly cost of at least $70 is needed to rationalize non-participation for a consumer with log utility and who can trade in the S&P500 CI. This lower bound declines rapidly in risk aversion for levels of risk aversion up to two/three; for higher values, it levels off. A yearly cost of at least $31 is needed to rationalize non-participation for a consumer with log utility and who can trade in US Treasury Bills. This lower bound rises steadily in risk aversion.

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Paper provided by Bank of Italy, Economic Research Department in its series Temi di discussione (Economic working papers) with number 415.

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Date of creation: Aug 2001
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Handle: RePEc:bdi:wptemi:td_415_01

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Related research
Keywords: household portfolio allocation; financial market participation; transaction costs; heterogeneous consumers;

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
D21 - Microeconomics - - Production and Organizations - - - Firm Behavior

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Francesco Spadafora, 2002. "Financial crises, moral hazard and the "speciality" of the international interbank market: further evidence from the pricing of syndicated bank loans to emerging markets," Temi di discussione (Economic working papers) 438, Bank of Italy, Economic Research Department. [Downloadable!]
  2. 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. [Downloadable!]
    Other versions:
  3. Sule Alan, 2005. "Entry Costs and Stock Market Participation Over the Life Cycle," Working Papers 2005_1, York University, Department of Economics. [Downloadable!]
    Other versions:
  4. Yannis Bilias & Michael Haliassos, 2004. "The Distribution of Gains from Access to Stocks," CSEF Working Papers 125, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
  5. Luigi Guiso & Tullio Jappelli, 2003. "Awareness and Stock Market Participation," CSEF Working Papers 110, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
    Other versions:
  6. Miquel Faig & Pauline Shum, 2006. "What Explains Household Stock Holdings?," Working Papers tecipa-218, University of Toronto, Department of Economics. [Downloadable!]
    Other versions:
  7. M. Fatih Guvenen, 2002. "Does Stockholding Provide Perfect Risk Sharing?," RCER Working Papers 490, University of Rochester - Center for Economic Research (RCER), revised Mar 2003. [Downloadable!]
    Other versions:
  8. Guiso, Luigi & Haliassos, Michalis & Jappelli, Tullio, 2003. "Household Stockholding in Europe: Where Do We Stand, and Where Do We Go?," CEPR Discussion Papers 3694, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  9. Xavier Ragot, 2008. "The case for a financial approach to money demand," PSE Working Papers 2008-56, PSE (Ecole normale supérieure). [Downloadable!]
  10. Jaime Ruiz-Tagle, 2006. "Financial Markets Incompleteness and Inequality Over the Life-Cycle," Working Papers Central Bank of Chile 405, Central Bank of Chile. [Downloadable!]
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This page was last updated on 2009-11-11.

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