Working Paper: NBER ID: w15227
Authors: Yosef Bonaparte; Russell Cooper
Abstract: This paper studies the dynamic optimization problem of a household when portfolio adjustment is costly. The analysis is motivated by the observation that on an annual basis, less than 71% of stockholders typically adjust their portfolio of common stocks. We use this, and related observations, to estimate the parameters of household preferences and portfolio adjustment costs. We find significant adjustment costs, beyond the direct costs of buying and selling assets. These adjustment costs and the consequent inactivity in portfolio adjustment imply that inferences drawn about household risk aversion and the elasticity of intertemporal substitution are biased: household risk aversion is lower compared to other estimates and it is not equal to the inverse of the elasticity of intertemporal substitution.
Keywords: portfolio adjustment; risk aversion; elasticity of intertemporal substitution
JEL Codes: E21; E44; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| portfolio adjustment costs (G11) | inactivity among stockholders (G34) |
| inactivity among stockholders (G34) | biased estimates of household risk aversion (D11) |
| inactivity among stockholders (G34) | biased estimates of elasticity of intertemporal substitution (EIS) (C51) |
| adjustment costs (J30) | lower degree of risk aversion (D11) |
| dynamic optimization problem (C61) | lower degree of risk aversion (D11) |
| cost of adjustment (F32) | influence on household consumption decisions (D12) |
| coefficient on interest rates (E43) | helps infer risk aversion (D81) |