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Costly Portfolio Adjustment

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  • Yosef Bonaparte
  • Russell Cooper
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    Abstract

    This paper studies the dynamic optimization problem of a household when portfolio adjustment is costly. The analysis is motivated by the observation that on a monthly basis, less than 10% of stockholders typically adjust their portfolio of common stocks. We use this, and related observations, to estimate the parameters of household preferences and portfolio adjustment costs. We find significant adjustment costs, beyond the direct costs of buying and selling assets. These adjustment costs imply that inferences drawn about household risk aversion and the elasticity of intertemporal substitution are biased: household risk aversion is lower compared to other estimates and it is not equal to the inverse of the elasticity of intertemporal substitution.

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    File URL: http://cadmus.eui.eu/dspace/bitstream/1814/13794/1/ECO2010_19.pdf
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    Bibliographic Info

    Paper provided by European University Institute in its series Economics Working Papers with number ECO2010/19.

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    Date of creation: 2010
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    Handle: RePEc:eui:euiwps:eco2010/19

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    References

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    1. Christopher D. Carroll, 1997. "Death to the Log-Linearized Consumption Euler Equation! (And Very Poor Health to the Second-Order Approximation)," NBER Working Papers 6298, National Bureau of Economic Research, Inc.
    2. Robert E. Hall, 1988. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc.
    3. 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.
    4. Mankiw, N.G. & Zeldes, S.P., 1990. "The Consumption Of Stockholders And Non-Stockholders," Weiss Center Working Papers 23-90, Wharton School - Weiss Center for International Financial Research.
    5. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June.
    6. Russell Cooper & John Haltiwanger & Jonathan L. Willis, 2010. "Euler-Equation Estimation for Discrete Choice Models: A Capital Accumulation Application," Economics Working Papers ECO2010/21, European University Institute.
    7. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
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    Cited by:
    1. Luigi Guiso & Paola Sapienza & Luigi Zingales, 2013. "Time Varying Risk Aversion," NBER Working Papers 19284, National Bureau of Economic Research, Inc.

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