The Forgone Gains of Incomplete Portfolios
42 Pages Posted: 24 May 2007
Date Written: April 2007
This paper proposes a test for the cost-based explanation of non-participation, by estimating a lower bound to the forgone gains of incomplete portfolios; these are in turn a lower bound to the costs that could rationalize non-participation in financial markets: high bounds would imply implausibly high costs. Assuming isoelastic utility and a relative risk aversion of 3 or less, for the stock market I estimate an average lower bound of between 0.7 and 3.3 percent of consumption. Since total annual (observable plus unobservable) participation costs are likely to exceed these bounds, the cost-based explanation is not rejected by this test.
Keywords: intertemporal consumption model, financial market participation, household portfolio allocation, non-proportional costs of participation
JEL Classification: E21, G11, D12
Suggested Citation: Suggested Citation