Working Paper: CEPR ID: DP2822
Authors: Michael Haliassos; Alex Michaelides
Abstract: We study the infinite horizon model of household portfolio choice under liquidity constraints and revisit the portfolio specialization puzzle for impatient consumers with access to riskless and risky assets. We consider a labour income process that allows us to decompose the consumption and portfolio effects of permanent and transitory shocks to labour income and show their interaction with liquidity constraints and their relative importance in producing precautionary effects and the portfolio specialization result. We show why the puzzle has proved robust for a number of model variations attempted in the literature, and argue that positive correlation between earnings shocks and stock returns is unlikely to provide a plausible resolution. We then offer an alternative explanation for observed stock holding patterns and the slow emergence of an equity culture. Specifically, we find that relatively small, fixed, stock market entry costs are sufficient to deter households from participating in the stock market. Such entry costs could arise, for example, from informational considerations, sign-up fees and investor inertia.
Keywords: buffer stock; saving; entry costs; liquidity constraints; portfolio choice; precautionary saving
JEL Codes: E20; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity constraints (E41) | household portfolio choices (D14) |
| liquidity constraints (E41) | zero stock and bond holdings (G12) |
| fixed entry costs (G31) | stock market participation (G10) |
| liquidity constraints + fixed entry costs (D25) | stockholding behavior (D14) |
| positive correlation between earnings shocks and stock returns (G17) | stockholding behavior (D14) |