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Intertemporal Consumption Choices, Transaction Costs and Limited Participation in Financial Markets: Reconciling Data and Theory

  • Orazio P. Attanasio
  • Monica Paiella

This paper builds a unifying framework based on the theory of intertemporal consumption choices that brings together the limited participation-based explanation of the C-CAPM poor empirical per- formance and the transaction costs-based explanation of incomplete portfolios. Using the implications of the consumption model and ob- served household consumption and portfolio choices, we identify the preference parameters of interest and a lower bound for the costs ra- tionalizing non-participation in nancial markets. Using the US Con- sumer Expenditure Survey and assuming isoelastic preferences, we es- timate the coe¢ cient of relative risk aversion at 1.7 and a cost bound of 0.4 percent of non-durable consumption. Our estimate of the pref- erence parameter is theoretically plausible and the bound su¢ ciently small to be likely to be exceeded by the actual total (observable and unobservable) costs of participating in nancial markets.

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Paper provided by D.E.S. (Department of Economic Studies), University of Naples "Parthenope", Italy in its series Discussion Papers with number 1_2008.

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Date of creation: 15 Feb 2008
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Handle: RePEc:prt:dpaper:1_2008
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  1. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
  2. Francisco Gomes & Alexander Michaelides, 2008. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 415-448, January.
  3. Samuelson, Paul A, 1969. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 239-46, August.
  4. Monica Paiella, 2007. "The forgone gains of incomplete portfolios," Temi di discussione (Economic working papers) 625, Bank of Italy, Economic Research and International Relations Area.
  5. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-62, April.
  6. 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.
  7. Luttmer, Erzo G J, 1996. "Asset Pricing in Economies with Frictions," Econometrica, Econometric Society, vol. 64(6), pages 1439-67, November.
  8. 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.
  9. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
  10. Francisco Gomes & Alexander Michaelides, 2005. "Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence," Journal of Finance, American Finance Association, vol. 60(2), pages 869-904, 04.
  11. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  12. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  13. Monica Paiella, 2004. "Heterogeneity in Financial Market Participation: Appraising its Implications for the C-CAPM," Review of Finance, Springer, vol. 8(3), pages 445-480.
  14. Attanasio, Orazio P & Weber, Guglielmo, 1989. "Intertemporal Substitution, Risk Aversion and the Euler Equation for Consumption," Economic Journal, Royal Economic Society, vol. 99(395), pages 59-73, Supplemen.
  15. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
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