Intertemporal Consumption Choices, Transaction Costs and Limited Participation in Financial Markets: Reconciling Data and Theory

33 Pages Posted: 23 May 2007

See all articles by Monica Paiella

Monica Paiella

University of Naples Federico II

Orazio Attanasio

Dept of Economics Yale University; Institute for Fiscal Studies (IFS); University College London - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: April 2007

Abstract

This paper builds a unifying framework based on the theory of intertemporal consumption choices that brings together the limited participation-based explanation of the C-CAPM poor empirical performance and the transaction costs-based explanation of incomplete portfolios. Using the implications of the consumption model and observed household consumption and portfolio choices, we identify the preference parameters of interest and a lower bound for the costs rationalizing non-participation in financial markets Assuming isoelastic preferences, we estimate the coefficient of relative risk aversion at 1.7 and a cost bound of 0.4 percent of non-durable consumption. Our estimate of the preference parameter is theoretically plausible and the bound sufficiently small to be likely to be exceeded by the actual total (observable and unobservable) costs of participating in financial markets.

Keywords: limited participation in financial markets, fixed participation costs, Euler equation for consumption

JEL Classification: E21, G11, G12

Suggested Citation

Paiella, Monica and Attanasio, Orazio, Intertemporal Consumption Choices, Transaction Costs and Limited Participation in Financial Markets: Reconciling Data and Theory (April 2007). Bank of Italy Temi di Discussione (Working Paper) No. 620, Available at SSRN: https://ssrn.com/abstract=987837 or http://dx.doi.org/10.2139/ssrn.987837

Monica Paiella (Contact Author)

University of Naples Federico II ( email )

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

Orazio Attanasio

Dept of Economics Yale University ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

Institute for Fiscal Studies (IFS)

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University College London - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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United Kingdom

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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