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Portfolio Choice And Liquidity Constraints

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Author Info
Michael Haliassos, Alexander Michaelides (University of Cyprus)

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Abstract

This paper generalizes Deaton's (1991) approach to saving under borrowing constraints to incorporate portfolio choice. For infinite horizon, impatient consumers, effects of risk aversion, prudence and temperance on portfolios can be different from those obtained in atemporal models. We confirm the surprising result of portfolio specialization in stocks (Heaton and Lucas, 1997) using a different earnings process, and we provide a rationale for why risk aversion and habit persistence cannot reverse it. We then show that positive correlation of stock returns with permanent, but not transitory, earnings shocks can generate demand for bonds and zero stockholding. However, existing empirical estimates of such correlations are at variance with portfolio data. We offer an alternative explanation of observed stock holding patterns based on fixed stock market entry costs. The entry cost required to keep impatient households out of the stock market is surprisingly small. This suggests that entry costs could generate the observed reluctance of households to undertake stockholding and explain the slowness in the emergence of an ``equity culture'' among households.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2000 with number 297.

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Date of creation: 05 Jul 2000
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Handle: RePEc:sce:scecf0:297

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Postal: CEF 2000, Departament d'Economia i Empresa, Universitat Pompeu Fabra, Ramon Trias Fargas, 25,27, 08005, Barcelona, Spain
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  3. Deaton, A. & Laroque, G., 1989. "On The Behavior Of Commodity Prices," Papers 8909, Institut National de la Statistique et des Etudes Economiques-.
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  4. Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1996. "Income Risk, Borrowing Constraints, and Portfolio Choice," American Economic Review, American Economic Association, vol. 86(1), pages 158-72, March. [Downloadable!] (restricted)
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  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. [Downloadable!] (restricted)
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  6. Orazio P. Attanasio & James Banks & Sarah Tanner, 2002. "Asset Holding and Consumption Volatility," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 771-792, August. [Downloadable!] (restricted)
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  7. Pischke, Jorn-Steffen, 1995. "Individual Income, Incomplete Information, and Aggregate Consumption," Econometrica, Econometric Society, vol. 63(4), pages 805-40, July. [Downloadable!] (restricted)
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  32. Haliassos, Michael & Hassapis, Christis, 2001. "Non-expected Utility, Saving and Portfolios," Economic Journal, Royal Economic Society, vol. 111(468), pages 69-102, January. [Downloadable!] (restricted)
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  34. Sydney C. Ludvigson & Alexander Michaelides, 2001. "Does Buffer-Stock Saving Explain the Smoothness and Excess Sensitivity of Consumption?," American Economic Review, American Economic Association, vol. 91(3), pages 631-647, June. [Downloadable!] (restricted)
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