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Entry Costs and Stock Market Participation Over the Life Cycle

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Author Info
Sule Alan

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Abstract

Several explanations for the observed limited stock market participation have been offered in the literature. One of the most promising one is the presence of market frictions mostly in the form of fixed entry and/or transaction costs. Empirical studies strongly point to a significant structural (state) dependence in the stock market entry decision, which is consistent with costs of these types. However, the magnitude of these costs are not yet known. This paper focuses on fixed stock market entry costs. I set up a structural estimation procedure which involves solving and simulating a life cycle intertemporal portfolio choice model augmented with a fixed stock market entry cost. Important features of household portfolio data (from the PSID) are matched to their simulated counterparts. Utilizing a Simulated Minimum Distance estimator, I estimate the coefficient of relative risk aversion, the discount factor and the stock market entry cost. Given the equity premium and the calibrated income process, I estimate a one-time entry cost of approximately 2 percent of (annual) permanent income. My estimated model matches the zero median holding as well as the hump-shaped age-participation profile observed in the data.

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Paper provided by McMaster University in its series Social and Economic Dimensions of an Aging Population Research Papers with number 126.

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Length: 49 pages
Date of creation: Jan 2005
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Handle: RePEc:mcm:sedapp:126

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Related research
Keywords: entry costs; stock market; structural estimation;

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving

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References listed on IDEAS
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    Other versions:
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    Other versions:
  3. George Hall & John Rust, 2002. "Econometric Methods for Endogenously Sampled Time Series: The Case of Commodity Price Speculation in the Steel Market," Cowles Foundation Discussion Papers 1376, Cowles Foundation, Yale University. [Downloadable!]
    Other versions:
  4. Steven J. Davis & Paul Willen, 2000. "Occupation-Level Income Shocks and Asset Returns: Their Covariance and Implications for Portfolio Choice," CRSP working papers 523, Center for Research in Security Prices, Graduate School of Business, University of Chicago. [Downloadable!]
    Other versions:
  5. Javier Alvarez & Martin Browning & Mette Ejrnæs, 2001. "Modelling Income Processes with lots of heterogeneity," CAM Working Papers 2002-01, University of Copenhagen. Department of Economics. Centre for Applied Microeconometrics. [Downloadable!]
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  6. Annette Vissing-Jorgensen, 2002. "Towards an Explanation of Household Portfolio Choice Heterogeneity: Nonfinancial Income and Participation Cost Structures," NBER Working Papers 8884, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Sule Alan & Martin Browning, 2003. "Estimating Intertemporal Allocation Parameters using Simulated Residual Estimation," CAM Working Papers 2003-03, University of Copenhagen. Department of Economics. Centre for Applied Microeconometrics. [Downloadable!]
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  21. repec:cup:etheor:v:12:y:1996:i:4:p:657-81 is not listed on IDEAS
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  23. Polkovnichenko, Valery, 2004. "Limited stock market participation and the equity premium," Finance Research Letters, Elsevier, vol. 1(1), pages 24-34, March. [Downloadable!] (restricted)
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  26. Carroll, Christopher D. & Samwick, Andrew A., 1997. "The nature of precautionary wealth," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 41-71, September. [Downloadable!] (restricted)
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  27. Cagetti, Marco, 2003. "Wealth Accumulation over the Life Cycle and Precautionary Savings," Journal of Business & Economic Statistics, American Statistical Association, vol. 21(3), pages 339-53, July.
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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. Francisco Gomes & Alexander Michaelides & Valery Polkovnichenko, 2009. "Optimal Savings with Taxable and Tax-Deferred Accounts," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(4), pages 718-735, October. [Downloadable!] (restricted)
    Other versions:
  2. 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. [Downloadable!] (restricted)
    Other versions:
  3. Sule Alan & Søren Leth-Petersen, 2006. "Tax Incentives and Household Portfolios: A Panel Data Analysis," Social and Economic Dimensions of an Aging Population Research Papers 163, McMaster University. [Downloadable!]
    Other versions:
  4. 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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