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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

    (University College London)

  • Monica Paiella

    ()
    (Bank of Italy)

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 C-CAPM 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 Assuming isoelastic preferences, we estimate the coefficient of relative risk aversion at 1.7 and a cost bound of 0.4 percent 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.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 620.

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Date of creation: Apr 2007
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Handle: RePEc:bdi:wptemi:td_620_07

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Keywords: limited participation in financial markets; fixed participation costs; Euler equation for consumption.;

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References

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  1. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  2. 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.
  3. 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.
  4. 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.
  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. 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.
  7. Francisco Gomes & Alexander Michaelides, 2005. "Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence," Journal of Finance, American Finance Association, vol. 60(2), pages 869-904, 04.
  8. 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.
  9. Orazio Attanasio & James Banks & Sarah Tanner, 1998. "Asset holding and consumption volatility," IFS Working Papers W98/08, Institute for Fiscal Studies.
  10. 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.
  11. 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.
  12. 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.
  13. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  14. Francisco Gomes & Alexander Michaelides, 2008. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 415-448, January.
  15. Luttmer, Erzo G J, 1996. "Asset Pricing in Economies with Frictions," Econometrica, Econometric Society, vol. 64(6), pages 1439-67, November.
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Cited by:
  1. 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.
  2. Luigi Guiso & Paolo Sodini, 2012. "Household Finance. An Emerging Field," EIEF Working Papers Series 1204, Einaudi Institute for Economics and Finance (EIEF), revised Mar 2012.
  3. 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".
  4. Khorunzhina, Natalia, 2011. "Dynamic Stock Market Participation of Households," MPRA Paper 35310, University Library of Munich, Germany.
  5. 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.
  6. 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.
  7. 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.
  8. Sheng Guo, 2009. "Switching Regression Estimates of EIS for Stockholders and Non-Stockholders," Working Papers 0903, Florida International University, Department of Economics.

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