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Revisiting the Implications of Heterogeneity in Financial Market Participation for the C-CAPM

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  • Monica Paiella

    () (Bank of Italy, Research Department)

Abstract

Recent studies have explored the possibility that accounting for limited participation in financial markets, and in the stock market in particular, might rationalize the empirical inconsistency of the Consumption-based Capital Asset Pricing Model (C-CAPM). The rational behind this stand is that if non-shareholders� consumption growth co-varies with share returns less than shareholders�, including their expenditure in the consumption measure used to test the model will be misleading. This paper reviews extensively the implications of household portfolio heterogeneity for various well-known characterizations of the empirical failure of the model, such as the inconsistency of consumption-based asset pricing factors with Hansen and Jagannathan bounds, the equity premium puzzle and the rejection of the overidentifying restrictions to the model. Specifically, it provides a unified framework of analysis, based on the US Consumer Expenditure Survey, to assess to what extent the empirical inconsistency of the C-CAPM can be attributed to the use of aggregate data that do not allow to account for limited participation in asset markets. The evidence from the analysis provides support to the view that accounting for portfolio heterogeneity improves the empirical performance of the model and helps rationalize some of the puzzling findings. However, heterogeneity in financial market participation alone does not appear to be enough to reconcile fully the theory with the empirical evidence.

Suggested Citation

  • Monica Paiella, 2003. "Revisiting the Implications of Heterogeneity in Financial Market Participation for the C-CAPM," Temi di discussione (Economic working papers) 473, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_473_03
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    File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/2003/2003-0473/tema_473_03.pdf
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    References listed on IDEAS

    as
    1. Domenica J. Marchetti, 1999. "Markup and the Business Cycle: Evidence from Italian Manufacturing Branches," Temi di discussione (Economic working papers) 362, Bank of Italy, Economic Research and International Relations Area.
    2. Bonaccorsi di Patti, Emilia & Gobbi, Giorgio, 2001. "The changing structure of local credit markets: Are small businesses special?," Journal of Banking & Finance, Elsevier, vol. 25(12), pages 2209-2237, December.
    3. Piero Cipollone, 2001. "La convergenza dei salari manifatturieri in Europa," Temi di discussione (Economic working papers) 398, Bank of Italy, Economic Research and International Relations Area.
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    Citations

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    Cited by:

    1. Monica Paiella, 2007. "The Forgone Gains of Incomplete Portfolios," Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1623-1646, 2007 13.
    2. Luigi Guiso & Monica Paiella & Ignazio Visco, 2005. "Do capital gains affect consumption? Estimates of wealth effects from Italian households� behavior," Temi di discussione (Economic working papers) 555, Bank of Italy, Economic Research and International Relations Area.
    3. Paiella, Monica, 2007. "Does wealth affect consumption? Evidence for Italy," Journal of Macroeconomics, Elsevier, vol. 29(1), pages 189-205, March.
    4. Guido De Blasio, 2004. "Does trade credit substitute for bank credit?," Temi di discussione (Economic working papers) 498, Bank of Italy, Economic Research and International Relations Area.

    More about this item

    Keywords

    Consumption-based Capital Asset Pricing Model; limited participation to financial markets;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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