Limited Stock Market Participation Research Articles

Reference-dependent preferences and stock market participation

ABSTRACT Prospect theory was proposed mainly to explain irrational investment behaviour. However, empirical evidence has come mostly from controlled experiments, and evidence from real data is rare. This paper uses panel data from a nationally representative survey in China to test whether prospect theory can explain stock market participation. The empirical results show that individuals take expected income as a reference point when investing in stocks. After real income and other factors are controlled for, the relative loss between expected and real income increases by 10,000 RMB, the probability of holding stocks increases by 0.77% and stock investment increases by 11.78%. The mechanism behind this is that relative losses motivate individuals to take excessive risks to hedge losses, while relative gains increase risk aversion and the holding of safe assets. These results can explain the puzzle of limited stock market participation. Participation costs are the main factor that restricts the low-income group from participating in the stock market, while the high-income group often faces relative gains, which leads to increased risk aversion and unwillingness to hold stocks.

Subjective expectations, experiences, and stock market participation: Evidence from the lab

Abstract Recent evidence suggests that stock market experiences, i.e. realized returns, impact subjective expected returns. I bring a model into the laboratory and find that experience-based subjective expected returns can help explain limited stock market participation. In the experiment, the probability of subjects participating in the stock market is increasing in both their subjective expected returns and past realized returns. I find that “learning from experience” generates heterogeneity in subjective expected returns, where subjects who “experience” low returns have lower subjective expected returns than subjects who only observe low returns. This experience effect is asymmetric, where subjects who experience high returns have no statistically significant difference in their subjective expected returns than subjects who only observe high returns. Finally, after a series of low returns, a fraction of subjects leave the stock market indefinitely.

Expectations and Stock Market Participation: Theory and Evidence

Recent evidence suggests that stock market experiences, i.e. realized returns, impact subjective expected returns. I bring a model into the laboratory and find that experience-based subjective expected returns can help explain limited stock market participation. In the experiment, the probability of subjects participating in the stock market is increasing in both their subjective expected returns and past realized returns. I find that learning from generates heterogeneity in subjective expected returns, where subjects who low returns have lower subjective expected returns than subjects who only observe low returns. This experience effect is asymmetric, where subjects who experience high returns have no statistically significant difference in their subjective expected returns than subjects who only observe high returns. Finally, after a series of low returns, a fraction of subjects leave the stock market indefinitely.

Technology shocks and hours revisited: Evidence from household data

I exploit heterogeneous impulse responses at the household level due to limited stock market participation to provide novel evidence on the degree of nominal rigidities. A number of studies show that positive technology shocks reduce aggregate hours. The finding is often interpreted as evidence in favor of sticky prices. Using the Consumer Expenditure Survey, I show that, while non-stockholders reduce hours in response to a positive technology shock, stockholders increase them. Aggregate hours fall because most households are non-stockholders. This finding is inconsistent with models featuring a high degree of nominal rigidities.

Limited Stock Market Participation Among Renters and Homeowners

Abstract The stock market participation rate among homeowners is twice as high as among renters. This paper builds a life-cycle portfolio choice model with endogenous housing tenure choice. A stylized form of preference heterogeneity generates a substantial difference in participation rates. A majority of households have a large savings motive and choose to be homeowners and participate. A minority of households have a small savings motive and find it less worthwhile to participate. Fewer of these households become homeowners. Difference-in-difference regressions on panel data do not find evidence of a crowding-out effect of homeownership on participation, supporting the message that preference heterogeneity matters. Received January 25, 2017; editorial decision March 21, 2018 by Editor Wei Jiang. Authors have furnished an Online Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

PORTFOLIO REBALANCING AND ASSET PRICING WITH HETEROGENEOUS INATTENTION

AbstractCan households' inattention to the stock market quantitatively account for the inertia in portfolio rebalancing? I address this question by introducing an observation cost into a production economy with heterogeneous agents. In this environment, inattention changes endogenously over time and across agents. I find that inattention explains the inertia in portfolio rebalancing and its heterogeneity across households. Inattention also rationalizes the limited stock market participation observed in the data and improves the asset pricing performance of the model. Finally, I present a novel testable implication linking the effects of inattention on portfolio choices and asset prices to households' funding liquidity.

Understanding Portfolio Performance: Is Luck Very Persistent?

We develop a parsimonious econometrics methodology to estimate individual’s portfolio return process accounting for self-selection bias from portfolio adjustment; our approach is useful to assist investors learning own return process profile. We study three components to characterize investor’s performance process: individual’s specifics, aggregate shocks, and idiosyncratic shocks. We find that individual investor returns are subject to shocks with modest persistence. Our results have implications for the calibration for the portfolio return in stochastic growth model which, in turn, have further implications for a host of other issues in financial economics such as limited stock market participation, the equity premium puzzle, and accounting for wealth inequality.

Technology Shocks and Hours Revisited: Evidence from Household Data

I exploit heterogeneous impulse responses at the household level due to limited stock market participation to provide novel evidence on the degree of nominal rigidities. A number of studies show that positive technology shocks reduce aggregate hours. The finding is often interpreted as evidence in favor of sticky prices. Using the Consumer Expenditure Survey, I show that, while non-stockholders reduce hours in response to a positive technology shock, stockholders increase them. Aggregate hours fall because most households are non-stockholders. This finding is inconsistent with models featuring a high degree of nominal rigidities.

Portfolio Rebalancing and Asset Pricing with Heterogeneous Inattention

Can households’ inattention to the stock market quantitatively account for the inertia in portfolio rebalancing? I address this question by introducing an observation cost into a production economy with heterogeneous agents. In this environment inattention changes endogenously over time and across agents. I find that inattention explains the inertia in portfolio rebalancing and its heterogeneity across households. Inattention also rationalises the limited stock market participation observed in the data, and improves the asset pricing performance of the model. Finally, I present a novel testable implication linking the effects of inattention on portfolio choices and asset prices to households’ funding liquidity.

Structural Household Finance

I develop a model with incomplete markets, summarize the empirical facts about household investment portfolio with the National Survey of Family Income and Expenditure, a cross-sectional Japanese household survey, and estimate the structural parameters when the limited stock market participation exists. Because we cannot observe the dynamics of the individual portfolio only with the cross-sectional data, we cannot estimate the structural parameters of the dynamic model. I propose the Bayesian likelihood-free inference method to minimize both the density difference and the distance between policy functions, between the observed and the simulated values. We can find that the estimated relative risk aversion is around four. The estimation outcome implies that the model can mimic the observed household finance behavior well and the equity premium puzzle comes of a biased estimate caused by the representative agent assumption.

Limited Stock Market Participation and Goods Market Frictions: A Potential Resolution for Puzzles in International Finance

The popular assumption based on complete markets that the log of real exchange rate growth equals the difference between the logs of home and foreign IMRSs imposes a tight restriction on explaining the joint behavior of asset prices, exchange rates, and international risk sharing. We study asset prices, exchange rates, and consumption dynamics in a general equilibrium two-country macro-finance model that features both asset-market and goods-market frictions. For the asset-market friction, we consider limited stock market participation a la Guvenen (2009). In addition, we follow Corsetti, Dedola, and Leduc (2008) to model frictions to international trade such as non-traded goods and distribution cost. We provide analysis of the model linearized to the second order, by implementing the method proposed by Devereux and Sutherland (2010) to overcome the indeterminacy issues with portfolio choice. The model generates a high price of risk, smooth exchange rates, and makes substantial progress towards explaining the empirically observed low consumption growth correlation between countries. We find that distribution cost plays a central role for reducing international consumption co-movement while also amplifying risk premia.

Limited Stock Market Participation in Ghana: A Behavioral Explanation

Purpose: The level of participation in stock markets has generally been low, leading to a phenomenon called the stock holding puzzle. There is a general agreement that participation levels in the Ghana stock Exchange are extremely low. The Ghana Statistical Service reveals that approximately (only) one (1) percent of Ghanaian households hold shares of stock. Many have attempted to explain this phenomenon using the basic features of a stock which are its risk and return components. Despite the extensive research conducted to find rational explanations to the stock holding puzzle and the general agreement that there exist a risk-return trade-off in the stock market, these studies have not been able to give a conclusive explanation to the stock holding puzzle. This study therefore seeks to find out the behavioral factors that influence an individual or household’s decision to participate in the stock market in Ghana and to generally investigate the determinants of stock market participation in the country.Methodology: The study employed an empirical regression model based on the behavioral finance framework which has been used by several studies. Findings: The research revealed that awareness of the stock market, trust, education and herding behaviour were positively and significantly related to stock market participation in Ghana.Recommendations: The study therefore recommended that, the Ghana Stock Exchange should embark on a massive public education programme to create public awareness of the stock market.

Cognitive Abilities, Social Trust and Stock Market Participation

English Abstract: This paper studies the impact of cognitive abilities and social trust on stock market ownership decisions. We set up a theoretical framework based on the portfolio choice model and find that these two distinct channels not only contribute to lowering the threshold of investment in stocks, but also help to increase the optimal proportion invested in stocks. Exploiting the survey data from China Family Panel Studies in 2012, we find that, all other things equal, cognitive abilities and social trust can significantly add to the possibility of households’ participation in stock market, and conditional on participation, the proportion invested in stocks is higher. These results are robust to different models and samples. Our research provides a beneficial perspective to understand the limited stock market participation and deepen the reforms of Chinese capital markets.

A simple asset pricing model with heterogeneous agents, uninsurable labor income and limited stock market participation

Abstract In this paper we study a simple two-period asset pricing model to understand the implications of uninsurable labor income risk and/or borrowing constraints, limited stock market participation, heterogeneous labor income volatilities, and heterogeneous preferences. We appraise the performance of each of these in matching moments of asset returns to the data and show that limited stock market participation generates a significantly large equity premium. We also show that the distribution of wealth between stock market participants and non-participants plays an important role in asset pricing, and that the effect of borrowing constraints on asset returns are similar to that of limited participation. Finally, we discuss the practical implications of our investigation, providing an appraisal of ongoing changes in asset returns.

Asset pricing with heterogeneous preferences, beliefs, and portfolio constraints

Portfolio constraints are widespread and have significant effects on asset prices. This paper studies the effects of constraints in a dynamic economy populated by investors with different risk aversions and beliefs about the rate of economic growth. The paper provides a comparison of various constraints and conditions under which these constraints help match certain empirical facts about asset prices. Under these conditions, borrowing and short-sale constraints decrease stock return volatilities, whereas limited stock market participation constraints amplify them. Moreover, borrowing constraints generate spikes in interest rates and volatilities and have stronger effects on asset prices than short-sale constraints.

Asset Pricing with Heterogeneous Preferences, Beliefs, and Portfolio Constraints

Portfolio constraints are widespread and have significant effects on asset prices. This paper studies the effects of constraints in a dynamic economy populated by investors with different risk aversions and beliefs about the rate of economic growth. The paper provides a comparison of various constraints and conditions under which these constraints help match certain empirical facts about asset prices. Under these conditions, borrowing and short-sale constraints decrease stock return volatilities, whereas limited stock market participation constraints amplify them. Moreover, borrowing constraints generate spikes in interest rates and volatilities and have stronger effects on asset prices than short-sale constraints.

Is consumption risk priced in the stock market?

Abstract The paper examines whether the risk in the consumption of stockholders caused by incomplete consumption insurance is priced in the cross-section of average stock returns. Using Taylor series expansion of the average marginal utility of consumption, we show that the risk in the consumption of stock market participants can be decomposed into two components, insurable (hedgeable using financial assets) and uninsurable (caused by incomplete consumption insurance) consumption risks. We argue that the growth rate of average consumption may be viewed as a proxy for the insurable component of consumption risk, while the growth rates of the rescaled higher-order cross-sectional consumption distribution moments may be regarded as a multivariate proxy for uninsurable risk in consumption. Exploiting microlevel household quarterly consumption data from the US Consumer Expenditure Survey, we find that both components of consumption risk are significantly priced when the limited stock market participation is taken into account. Neither the insurable and uninsurable components of consumption risk nor the Fama–French risk factors are rejected as capturing important components of systematic risk when tested against each other in an integrated multifactor asset pricing model.

Inflation, Money Demand and Portfolio Choice

We introduce a money demand motive in a life-cycle portfolio choice model and estimate the structural parameters that can generate limited stock market participation and plausible holdings of money, bonds and stocks. The model predicts an increase in bond holdings over the life cycle, and a declining share of money in portfolios as wealth increases. Both predictions are consistent with the data, even though the model overpredicts (underpredicts) stock (bond) holdings in early life. When mean inflation approaches zero, the share of money in the financial portfolio rises at the expense of both bond and stockholdings, generating simultaneously a lower stock market participation rate.

A Simple Asset Pricing Model with Heterogeneous Agents, Uninsurable Labor Income and Limited Stock Market Participation

In this paper we study a simple two-period asset pricing model to understand the implications of uninsurable labor income risk and/or borrowing constraints, limited stock market participation, heterogeneous labor income volatilities, and heterogeneous preferences. We appraise the performance of each of these in matching moments of asset returns to the data and show that limited stock market participation generates a significantly large equity premium. We also show that the distribution of wealth between stock market participants and non-participants plays an important role in asset pricing, and that the effect of borrowing constraints on asset returns are similar to that of limited participation. Finally, we discuss the practical implications of our investigation, providing an appraisal of ongoing changes in asset returns.

The Implications of Limited Stock Market Participation for International Risk Sharing and Asset Prices

I study international consumption risk sharing with limited stock market participation in each country. Novel micro-level household consumption data in the U.S. and U.K. show that the stockholders' cross-country consumption growth correlation is considerably higher than that of the aggregate consumption growth. I develop an incomplete market model that features this new empirical evidence by incorporating limited risk sharing due to limited stock market participation. Moreover, the model generates high international equity return correlation, low aggregate consumption growth correlation, and salient features of asset prices (high and volatile equity premium, low and smooth risk free rate). Financial integration significantly improves the stockholders' international consumption risk sharing, reduces their consumption volatility, and increases their welfare. However, the benefits are almost all captured by the stockholders.