Portfolio Choice and Liquidity Constraints
Posted: 25 Sep 2001
We study the infinite horizon model of household portfolio choice under liquidity constraints and revisit the portfolio specialization puzzle. We show why the puzzle is robust to several model variations, and argue that positive correlation between earnings shocks and stock returns is unlikely to provide an empirically plausible resolution. We find that relatively small fixed costs for stock market entry are sufficient to deter stockholding because, for a plausible range of parameter values, households can achieve desired consumption smoothing with small or zero holdings of stocks. Such costs could arise from informational considerations, sign-up fees, and investor inertia.
Keywords: Precautionary Saving, Portfolio Choice, Liquidity Constraints, Buffer Stock Saving, Entry Costs
JEL Classification: G11, E20
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