Limited Participation and Consumption-Saving Puzzles: A Simple Explanation and the Role of Insurance

42 Pages Posted: 17 Mar 2006 Last revised: 17 Jun 2014

See all articles by Todd A. Gormley

Todd A. Gormley

Washington University in St. Louis; European Corporate Governance Institute (ECGI)

Hong Liu

Washington University in St. Louis - Olin Business School; Fudan University - China Institute of Economics and Finance

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School

Date Written: June 15, 2009

Abstract

In this paper, we use a simple model to illustrate that the existence of a large, negative wealth shock and insufficient insurance against such a shock can potentially explain both the limited stock market participation puzzle and the low-consumption-high-savings puzzle that are widely documented in the literature. We then conduct an extensive empirical analysis on the relation between household portfolio choices and access to private insurance and various types of government safety nets, including social security and unemployment insurance. The empirical results demonstrate that a lack of insurance against large, negative wealth shocks is strongly correlated with lower participation rates and higher saving rates. Overall, the evidence suggests an important role of insurance in household investment and savings decisions.

Keywords: limited participation, saving, consumption, insurance

JEL Classification: D11, D91, G11, C61

Suggested Citation

Gormley, Todd A. and Liu, Hong and Zhou, Guofu, Limited Participation and Consumption-Saving Puzzles: A Simple Explanation and the Role of Insurance (June 15, 2009). Journal of Financial Economics (JFE), Vol. 96, No. 2, 2010, AFA 2009 San Francisco Meetings Paper, Available at SSRN: https://ssrn.com/abstract=891747 or http://dx.doi.org/10.2139/ssrn.891747

Todd A. Gormley

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
(314) 935-7171 (Phone)

HOME PAGE: http://www.gormley.info

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Hong Liu (Contact Author)

Washington University in St. Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-5883 (Phone)

Fudan University - China Institute of Economics and Finance ( email )

China

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

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