An Equilibrium Model with Restricted Stock Market Participation

Basak, Suleyman; Cuoco, Domenico

doi:10.1093/rfs/11.2.309

Cited by 536 publications

(388 citation statements)

References 34 publications

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“…In this paper, we demonstrate that a single driving force, insufficient insurance against 1 See, for example, Mankiw and Zeldes, 1991;Haliassos and Bertaut, 1995;Heaton and Lucas, 2000;and Guiso, Haliassos, and Jappelli, 2003. 2 See, for example, Basak and Cuoco, 1998;and Huang and Wang, 2007. 1 large negative shocks, might help explain both the limited participation and the LHCS puzzles.…”

Section: Finance | Finance and Financial Managementmentioning

confidence: 81%

Limited participation and consumption-saving puzzles: A simple explanation and the role of insurance☆

Gormley

Hong

Zhou

2010

Journal of Financial Economics

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In this paper, we show that the existence of a large, negative wealth shock and insufficient insurance against such a shock could explain both the limited stock market participation puzzle and the low-consumption-highsavings puzzle. We then conduct an empirical analysis on the relation between household portfolio choices and access to private insurance and various types of government safety nets. The empirical results demonstrate that a lack of insurance against large, negative wealth shocks is positively correlated with lower participation rates and higher saving rates. Overall, the evidence suggests an important role of insurance in household investment and savings decisions. 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. Disciplines Finance | Finance and Financial ManagementJournal of Economic Literature Classification Numbers: D11, D91, G11, C61.Keywords: Limited participation, Insurance, Saving, Consumption As Campbell states in his 2006 presidential address: "Textbook financial theory implies that all households, no matter how risk averse, should hold some equities if the equity premium is positive." But, it is well documented that less than 50 percent of households in the U.S., and far less in many other countries, participate in the stock market, 1 and that this limited participation has a significant impact on the equilibrium risk premium, diversification discount, liquidity, and market crashes. 2 It is also well documented that relative to their income, households in developing countries consume less and save more than those in developed countries (Cao and Modigliani, 2004). This gap is puzzling especially given the explicit effort by governments in many developing countries to discourage saving and promote consumption as a way to reduce dependence on foreign demand for economic growth.While there exist several possible explanations for the limited participation puzzle and the low-consumption-high-savings (LCHS) puzzle, there is little overlap in these explanations.The existing explanations for limited participation rates generally rely on either transactions costs (Vissing-Jorgensen, 2002), the existence of both learning and short-sale constraints for investors whose income has a positive correlation with the stock market ...

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Section: Finance | Finance and Financial Managementmentioning

confidence: 81%

Limited participation and consumption-saving puzzles: A simple explanation and the role of insurance☆

Gormley

Hong

Zhou

2010

Journal of Financial Economics

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“…There are a number of theories that suggest a link between the speed of information diffusion and limited stock market participation (Merton (1987), Basak and Cuoco (1998), Shapiro (2002), and Hou and Moskowitz (2005)). These models argue that institutional forces, information costs, or transaction costs can delay the process of information incorporation for less visible, segmented firms.…”

Section: Introductionmentioning

confidence: 99%

Do foreigners facilitate information transmission in emerging markets?

Bae

Ozoguz

Tan

et al. 2012

Journal of Financial Economics

212

104

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“…See Cuoco and He (2001) for a general approach in discrete time and Basak and Cuoco (1998) for a model with restricted stock market participation in continuous time.…”

Section: Planner's Problem and Optimal Allocationsmentioning

confidence: 99%

Survival and Long-Run Dynamics with Heterogeneous Beliefs Under Recursive Preferences

Borovička

2012

SSRN Journal

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An Equilibrium Model with Restricted Stock Market Participation

Cited by 536 publications

References 34 publications

Limited participation and consumption-saving puzzles: A simple explanation and the role of insurance☆

Limited participation and consumption-saving puzzles: A simple explanation and the role of insurance☆

Do foreigners facilitate information transmission in emerging markets?

Survival and Long-Run Dynamics with Heterogeneous Beliefs Under Recursive Preferences

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