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Durable Consumption and Asset Management with Transaction and Observation Costs

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  • Fernando Alvarez
  • Luigi Guiso
  • Francesco Lippi

Abstract

The empirical evidence on rational inattention lags far behind the theoretical developments: micro evidence on the most immediate consequence of observation costs - the infrequent observation of state variables - is not available in standard datasets. We contribute to filling the gap with two novel household surveys that record the frequency with which investors observe the value of their financial investments, as well as the frequency with which they trade in financial assets and durable goods. We use these data to test some predictions of existing models and show that to match the patterns in the data we need to modify these models by shifting the focus from non-durable to durable consumption. The model we develop features both observation and transaction costs and implies a mixture of time-dependent and state-dependent rules, where the importance of each rule depends on the ratio of the observation to the transaction cost. Numerical simulations show that the model can produce frequency of portfolio observations and asset trading comparable to that of the median investor (about 4 and 0.4 per year, respectively) with small observation costs (about 1 basis point of financial wealth)and larger transaction costs (about 30 basis points of financial wealth). In spite of its small size the observation cost gives rise to infrequent information gathering (between monthly and quarterly). A quantitative assessment of the relevance of the observation costs shows that the behavior of the investors is essentially unchanged compared to the one produced by a model with transaction but no observation cost. We test a novel prediction of the model on the relationship between assets trades and durable-goods trades and find that it is aligned with the data.

Suggested Citation

  • Fernando Alvarez & Luigi Guiso & Francesco Lippi, 2010. "Durable Consumption and Asset Management with Transaction and Observation Costs," Economics Working Papers ECO2010/04, European University Institute.
  • Handle: RePEc:eui:euiwps:eco2010/04
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    References listed on IDEAS

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    Cited by:

    1. Huynh, Kim P. & Schmidt-Dengler, Philipp & Stix, Helmut, 2014. "Whenever and Wherever: The Role of Card Acceptance in the Transaction Demand for Money," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 472, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    2. Fernando E. Alvarez & Francesco Lippi & Luigi Paciello, 2011. "Optimal Price Setting With Observation and Menu Costs," The Quarterly Journal of Economics, Oxford University Press, vol. 126(4), pages 1909-1960.
    3. Alvarez, Fernando & Lippi, Francesco, 2013. "The demand of liquid assets with uncertain lumpy expenditures," Journal of Monetary Economics, Elsevier, vol. 60(7), pages 753-770.
    4. repec:eee:jeborg:v:142:y:2017:i:c:p:378-395 is not listed on IDEAS
    5. Huynh, Kim P. & Schmidt-Dengler, Philipp & Stix, Helmut, 2014. "The Role of Card Acceptance in the Transaction Demand for Money," CEPR Discussion Papers 10183, C.E.P.R. Discussion Papers.
    6. Fabio Verona, 2014. "Investment Dynamics with Information Costs," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(8), pages 1627-1656, December.
    7. Guiso, Luigi & Sodini, Paolo, 2013. "Household Finance: An Emerging Field," Handbook of the Economics of Finance, Elsevier.
    8. Bubeck, Johannes & Habib, Maurizio Michael & Manganelli, Simone, 2017. "The portfolio of euro area fund investors and ECB monetary policy announcements," Working Paper Series 2116, European Central Bank.
    9. Arna Vardardottir & Michaela Pagel, 2016. "The Liquid Hand-to-Mouth: Evidence from a Personal Finance Management Software," 2016 Meeting Papers 789, Society for Economic Dynamics.
    10. Campanale, Claudio & Fugazza, Carolina & Gomes, Francisco J, 2015. "Life-Cycle Portfolio choice with Liquid and Illiquid Assets," CEPR Discussion Papers 10369, C.E.P.R. Discussion Papers.
    11. Jeffrey Butler & Luigi Guiso & Tullio Jappelli, 2014. "The role of intuition and reasoning in driving aversion to risk and ambiguity," Theory and Decision, Springer, pages 455-484.
    12. Jacopo Magnani & Aspen Gorry & Ryan Oprea, 2016. "Time and State Dependence in an Ss Decision Experiment," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(1), pages 285-310, January.
    13. Fernanda Nechio, 2010. "Foreign stock holdings: the role of information," Working Paper Series 2010-26, Federal Reserve Bank of San Francisco.
    14. Chien, YiLi & Naknoi, Kanda, 2015. "The risk premium and long-run global imbalances," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 299-315.
    15. Anil K. Kashyap & Dimitrios P. Tsomocos & Alexandros P. Vardoulakis, 2014. "How does macroprudential regulation change bank credit supply?," NBER Working Papers 20165, National Bureau of Economic Research, Inc.
    16. Milo Bianchi & Jean-Marc Tallon, 2014. "Ambiguity Preferences and Portfolio Choices: Evidence from the Field," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-01109655, HAL.
    17. Campanale, Claudio & Fugazza, Carolina & Gomes, Francisco, 2015. "Life-cycle portfolio choice with liquid and illiquid financial assets," Journal of Monetary Economics, Elsevier, vol. 71(C), pages 67-83.
    18. Nikolai Roussanov & Michael Michaux & Hui Chen, 2011. "Houses as ATMs? Mortgage Refinancing and Macroeconomic Uncertainty," 2011 Meeting Papers 1369, Society for Economic Dynamics.
    19. Xavier Gabaix, 2017. "Behavioral Inattention," NBER Working Papers 24096, National Bureau of Economic Research, Inc.
    20. Zeno Enders, 2017. "Heterogeneous Consumers, Segmented Asset Markets, and the Real Effects of Monetary Policy," CESifo Working Paper Series 6467, CESifo Group Munich.
    21. Riccardo Giacomelli & Elisa Luciano, 2011. "Equilibrium price of immediacy and infrequent trade," Carlo Alberto Notebooks 221, Collegio Carlo Alberto, revised 2013.
    22. Aubhik Khan & Julia Thomas, 2015. "Revisiting the Tale of Two Interest Rates with Endogenous Market Segmentation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(2), pages 243-268, April.
    23. Choi, James J. & Haisley, Emily & Kurkoski, Jennifer & Massey, Cade, 2017. "Small cues change savings choices," Journal of Economic Behavior & Organization, Elsevier, vol. 142(C), pages 378-395.
    24. Eickholt, Mathias & Entrop, Oliver & Wilkens, Marco, 2014. "Individual investors and suboptimal early exercises in the fixed-income market," Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe 14, University of Passau, Faculty of Business and Economics.
    25. repec:hal:journl:halshs-01109655 is not listed on IDEAS

    More about this item

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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