The Foregone Gains of Incomplete Portfolios
46 Pages Posted: 25 Feb 2005
Date Written: December 20, 2004
This paper estimates a lower bound to the foregone gains of incomplete portfolios, which are in turn a lower bound to the (unobserved) entry costs that could rationalize non-participation to financial markets. My estimates provide a heuristic test for the cost-based explanation of limited financial market participation: High estimates would imply implausibly high participation costs. Using the CEX and assuming isoelastic utility and a relative risk aversion of 3, I estimate a lower bound ranging between 1.1 and 6.3 percent of consumption. Since annual total (observable plus unobservable) participation costs are likely to exceed these bounds, the cost-based explanation is not rejected by this heuristic test.
Keywords: financial market participation, household portfolio allocation, non-proportional cost of participation, intertemporal consumption model
JEL Classification: G11, D12, E21
Suggested Citation: Suggested Citation