Portfolio Choice and Liquidity Constraints

47 Pages Posted: 7 Jun 2001

See all articles by Alexander Michaelides

Alexander Michaelides

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Michael Haliassos

Goethe University Frankfurt - House of Finance; Goethe University Frankfurt - Faculty of Economics and Business Administration; CEPR; NETSPAR

Multiple version iconThere are 4 versions of this paper

Date Written: June 2001

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 Classification: E20, G11

Suggested Citation

Michaelides, Alexander and Haliassos, Michael, Portfolio Choice and Liquidity Constraints (June 2001). CEPR Discussion Paper No. 2822. Available at SSRN: https://ssrn.com/abstract=272203

Alexander Michaelides

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Michael Haliassos (Contact Author)

Goethe University Frankfurt - House of Finance

Theodor-W.-Adorno-Platz 3
PF H32
Frankfurt am Main, 60323
Germany

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
PF H32
Frankfurt am Main, D-60323
Germany

CEPR

London
United Kingdom

NETSPAR ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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