The Foregone Gains of Incomplete Portfolios

46 Pages Posted: 25 Feb 2005

See all articles by Monica Paiella

Monica Paiella

University of Naples Federico II

Date Written: December 20, 2004

Abstract

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

Paiella, Monica, The Foregone Gains of Incomplete Portfolios (December 20, 2004). Institute of Fiscal Studies Working Paper No. 01-06, EFA 2005 Moscow Meetings Paper, Available at SSRN: https://ssrn.com/abstract=673161 or http://dx.doi.org/10.2139/ssrn.673161

Monica Paiella (Contact Author)

University of Naples Federico II ( email )

Via Amm. F. Acton, 38
80133 Naples, Caserta 80133
Italy

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