a class of tractable incomplete market models for studying asset returns and risk exposure abstract we present a class of tractable incomplete market models where agents face both aggregate risk and limited participation in financial markets tractability relies on the assumptions of small asset volumes and of a period utility function that is linear beyond a threshold in line with fishburn s 1977 contribution in decision theory we prove the existence of an equilibrium and derive theoretical results regarding asset prices and consumption choices this small trade model is able to reproduce a low safe return and a high equity premium together with a realistic representation of household exposure to both idiosyncratic and aggregate risks

portfolio choice and liquidity constraints we study the infinite horizon model of household portfolio choice under liquidity constraints and revisit the portfolio specialization puzzle we show why the puzzle is robust to several model variations and argue that positive correlation between earnings shocks and stock returns is unlikely to provide an empirically plausible resolution we find that relatively small fixed costs for stock market entry are sufficient to deter stockholding because for a plausible range of parameter values households can achieve desired consumption smoothing with small or zero holdings of stocks such costs could arise from informational considerations sign up fees and investor inertia

aggregate savings financial intermediation and interest rate there has been considerable controversy about the role of financial factors as determinants of savings in developing countries this paper explores the importance of two such factors namely real interest rate and financial intermediation using pooled time series cross section data a model of savings is estimated for asia latin america and for the total sample particular attention is paid to the error structure in estimation the results suggest that pooling is not justified further there is no unequivocal support for the effect of either of the two factors some qualified support is found for asia but none for latin america copyright 1987 by mit press

optimal inattention to the stock market with information costs and transactions costs recurrent intervals of inattention to the stock market are optimal if consumers incur a utility cost to observe asset values when consumers observe the value of their wealth they decide whether to transfer funds between a transactions account from which consumption must be financed and an investment portfolio of equity and riskless bonds transfers of funds are subject to a transactions cost that reduces wealth and consists of two components one is proportional to the amount of assets transferred and the other is a fixed resource cost because it is costly to transfer funds the consumer may choose not to transfer any funds on a particular observation date in general the optimal adjustment rule including the size and direction of transfers and the time of the next observation is state dependent surprisingly unless the fixed resource cost of transferring funds is large the consumer s optimal behavior eventually evolves to a situation with a purely time dependent rule with a constant interval of time between observations this interval of time can be substantial even for tiny observation costs when this situation is attained the standard consumption euler equation holds between observation dates if the consumer is sufficiently risk averse

comment on measuring poverty in a growing world or measuring growth in a poor world by angus deaton angus deaton discusses the ambiguity that arises from using different definitions and data sources for individual income or consumption levels in world poverty measurement should one rely on the direct information on individual consumption or income provided by national representative household surveys or should consumption and income figures be scaled up or down so that means coincide with national accounts na data it is generally the case that consumption expenditure per capita estimated in the na is higher than the mean expenditure per capita obtained in surveys thus scaling up leads to lower poverty estimates than when surveys are used it is also the case that the difference between the two estimates tends to widen over time so that trends are not more reliable than poverty estimates at one point of time deaton analyzes in detail the reasons for this divergence and concludes that na scaled survey data are in some sense faulty whereas a pure consistency argument pleads in favor of using surve

stockholding behavior of u s households evidence from the 1983 1989 survey of consumer finances most households persistently invest in riskless assets but not stocks and may do so because they perceive information required for market participation to be costly relative to expected benefits in a consumption capital asset pricing model ccapm increased risk aversion income risk and lower resources reduce the information expense sufficient to deter stockholding bivariate probit analysis using the 1983 1989 survey of consumer finances shows that households with lower risk aversion higher education and greater wealth who were nonstockholders in 1983 had an increased conditional probability of entering by 1989 whereas 1983 stockholders with lower resources more limited education and greater risk aversion were more likely to be nonstockholders by 1989

debt relief and the international enforcement of loan contracts it is now apparent that the governments of many developing countries will not repay their debts as initially contracted creditors have already forgiven loans to some poor borrowers in africa loans to several middle income borrowers mostly in latin america trade in secondary markets at enormous discounts below 10 percent of face value in some cases creditors and debtors are negotiating the status of these debts with relief now likely for them as well since 1983 the situation has been seen to be sufficiently troubled to constitute a debt crisis although whether the debts actually caused the stagnation and financial chaos in many debtor countries is questionable poor economic management at home along with some adverse changes abroad probably have more to do with their plight while the debts themselves may not have caused the crisis creditors and creditor governments must now adjust to the realization that full repayment is either infeasible or that enforcing full payment is undesirable from the point of view of creditor countries as a whole the question now is what to do with these debts the baker and brady plans have increased u s government involvement in the debt crisis and have allocated public money toward its resolution the kenen plan discussed in this issue proposes still more public involvement and in all likelihood more public money each of these plans is an ad hoc response to the impasse that has arisen between some highly indebted countries and their private creditors and aspects of each plan may help resolve this impasse but none of these plans confronts the features of international capital markets that led to the crisis in the first place my argument here is that the debt crisis that began in 1983 arose from defects in how international capital markets operated the previous decade a goal of any

optimal portfolio choice for long horizon investors with nontradable labor income this paper examines how risky labor income and retirement affect optimal portfolio choice with idiosyncratic labor income risk the optimal allocation to stocks is unambiguously larger for employed investors than for retired investors consistent with the typical recommendations of investment advisors increasing idiosyncratic labor income risk raises investors willingness to save and reduces their stock portfolio allocation towards the level of retired investors positive correlation between labor income and stock returns has a further negative effect and can actually reduce stockholdings below the level of retired investors financial advisors typically recommend that their customers invest more in stocks than in safe assets when they are working and to shift their investments towards safe assets when they retire jagannathan and kocherlakota 1996 malkiel 1996 by contrast the standard academic models of portfolio choice merton 1969 1971 samuelson 1969 show that retirement is irrelevant for portfolio decisions if investment opportunities are constant and human capital is tradable in this case the fraction of wealth optimally invested in risky assets should be constant over the lifetime of an individual recent research building on the pioneering work by merton 1971 shows that time varying investment opportunities result in portfolio rules with an intertemporal hedging component whose magnitude depends on the investment horizon of the investor kim and omberg 1996 balduzzi and lynch 1997 brennan schwartz and lagnado 1997 brandt 1999 campbell and viceira 1999 2001 barberis 2000 with time variation in investment opportunities retirement and death play an instrumental role as events that exogenously fix the individual s investment horizon more importantly retirement also marks the time at which individuals stop working and thereafter must live off their lifetime savings and possibly transfers from this perspective retirement matters for portfolio choice

portfolio choice in the presence of background risk in this paper we focus on how the presence of background risks from sources such as labour and entrepreneurial income influences portfolio allocations this interaction is explored in a theoretical model that is calibrated using cross sectional data from a variety of sources the model is shown to be consistent with some but not all aspects of cross sectional observations of portfolio holdings the paper also provides a survey of the extensive theoretical and empirical literature on portfolio choice

costly search and mutual fund flows this paper studies the flows of funds into and out of equity mutual funds consumers base their fund purchase decisions on prior performance information but do so asymmetrically investing disproportionately more in funds that performed very well the prior period search costs seem to be an important determinant of fund flows high performance appears to be most salient for funds that exert higher marketing effort as measured by higher fees flows are directly related to the size of the fund s complex as well as the current media attention received by the fund which lower consumers search costs

the management of the developing countries debt guidelines and applications to brazil some principles which may be useful in formulating a debt management strategy are articulated there are four major policy recommendations 1 stretch out the repayment of the debt 2 monitor both exports and gdp 3 ignore the capital loss of the creditors and 4 watch the domestic deficit the goal of the recommendations is the maximization of the intertemporal welfare of the country under the constraint that it services its debt

the family as an incomplete annuities market families can self insure against uncertain dates of death through implicit or explicit agreements with respect to consumption and interfamily transfers interfamily transfers need have nothing to do with altruistic feelings they may simply reflect risk sharing behavior of completely selfish family members although family annuity markets are incomplete even small families can substitute by more than 70 percent for perfect market annuities given adverse selection and transaction costs family risk pooling may be preferred to public market annuities in the absence of public annuities these risk sharing arrangements provide powerful incentives for marriage and family formation

how do consumers avoid penalty fees evidence from credit cards using data from multiple card issuers we show that the most common penalty fee type incurred by credit card holders late payment fees declines sharply over the first few months of card life thi

tax motivated trading by individual investors we study the stock trades of a large number of individual investors to investigate how tax incentives affect the realization of capital gains and losses we compare investors realization behavior in their taxable and tax deferred accounts and thereby identify the effect of taxes on trading decisions we reach four conclusions first we find clear evidence of a lock in effect for capital gains in taxable accounts relative to tax deferred accounts we find evidence of the disposition effect the tendency for investors to hold losses and sell gains in both types of accounts and especially at short holding periods the lock in effect is stronger for large stock transactions than for small ones second we find tax loss selling throughout the calendar year though it is most pronounced in december tax loss trading is more pronounced among investors who have realized capital gains elsewhere in the portfolio during the year third we observe substantial heterogeneity in individual investors propensity to trade controlling for this heterogeneity however does not alter the relation between a stock s past performance and the realization decision finally we find that relatively few investors repurchase stocks that they have sold at a loss even after the 30 day wash sale holding period has expired

myopic loss aversion and stock investments an empirical study of private investors abstract myopic loss aversion was suggested by benartzi and thaler 1995 as an explanation for the equity premium puzzle its main prediction is that loss averse investors who evaluate their investment performance too frequently and therefore often observe small losses on their stock portfolios would invest too little in equity we investigate the link between myopic loss aversion and actual investment decisions of individual investors using survey data our results are consistent with the predictions of benartzi and thaler higher myopic loss aversion is associated with lower stock investment as a share of total assets investors tend to evaluate their stock portfolio performance too often which contributes to the prevalence of myopic loss aversion the effect of myopia is most apparent when investors both evaluate their portfolios frequently and trade stocks regularly

external debt planning horizon and distorted credit markets the purpose of this paper is to study the behavior of the credit market and the role of policies in the presence of country risk with underdiscounting by the policy maker the underdiscounting may reflect political uncertainty where the effective planning horizon of the centralized government is shorter than that of the private sector the consequence of underdiscounting is to shift the supply curve facing the economy leftwards the role of optimal borrowing policies in the presence of country risk is to discourage borrowing for consumption purposes encourage investment in openness and discourage investment in activities that reduce openness the effect of underdiscounting by the policy maker is to increase the values of the optimal policy instruments i e to increase the magnitude of the borrowing taxes and subsidies increasing the relative importance of open activities can be viewed as a way to reduce the harmful consequences of underdiscounting underdiscounting may rationalize various conditionality clauses that will induce the economy to follow the desired credit market policies

permanent household income and consumption in urban south america milton friedman s permanent income hypothesis pih is considerably more complex and difficult to test than it appears at first sight which is why certain of its postulates still cannot be accepted or rejected with certainty one of the chief difficulties is that of separating the effects on consumption of permanent income which is unobservable and of various observable household characteristics which may be highly correlated with permanent income but may also be presumed to affect consumption directly this difficulty can be overcome provided a variable can be found which is associated with permanent income but has no independent direct effect on the propensity to consume if households are grouped by classes of that variable the permanent consumption propensity or elasticity can be estimated from mean income and consumption in the groups this technique requires the assumption of zero mean transitory income in each group but does not depend on the postulate that transitory income is uncorrelated with consumption for these reasons it cannot be applied to individual households this paper presents and estimates a model which separates the direct and indirect effects on consumption of a series of observable characteristics using regression techniques on individual household observations this makes it possible to estimate all the parameters of the model both the consumption propensity or elasticity and the contribution to permanent income of each observable explanatory variable the technique still requires that at least one of the explanatory variables affect consumption only through permanent income but for all other variables both direct and indirect influences can be estimated and the propensity to consume a given income can vary among households with different characteristics another principal problem with the pih is the assumption that transitory income and consumption are uncorrelated efforts to test this postulate can lead to very different results ranging from agreement with the hypothesis to findings of high propensities to consume transitory income see robert ferber pp 1306 09 this inconsistency and continued controversy over the hypothesis is due to the fact that permanent income cannot be estimated exactly but can be known only with an error which is conceptually distinct from transitory income empirical work on the pih has uniformly overlooked this fact treating estimates of permanent income as exact and regarding the whole of the unexplained residual as transitory income the present model explicitly distinguishes the estimation error from the error of transitory income or consumption the two transitory components can then be assumed to be uncorrelated while the part of permanent income which is not explained is consumed exactly like the explained part whether residual income and consumption appear to be correlated or not then depends on the relative sizes of these two components the unexplained permanent part and the true transitory part this technique has the further advantage that estimating the variance of the error of estimation makes it possible to tell how well a set of observable variables explain permanentincome this explanation may be better than the brookings institution robert solow richard eckaus and robert hall supervised the dissertation 1974 on which this article is based i am particularly grateful to ross williams and robert hall for help in specifying and estimating the model and to denisard alves for a crucial suggestion william cline irwin friend ricardo ffrench davis and robert ferber provided helpful comments on earlier versions subsequent discussions with surjit bhalla and robert lawrence have been most useful i am also much indebted to the managing editor and to a referee for improvements in the final version

portfolio choice and trading in a large 401 k plan we study nearly 7 000 retirement accounts during the april 1994 august 1998 period several interesting patterns emerge most asset allocations are extreme either 100 percent or zero percent in equities and there is inertia in asset allocations equity allocations are higher for males married investors and for investors with higher earnings and more seniority on the job equity allocations are lower for older investors there is very limited portfolio reshuffling in sharp contrast to discount brokerage accounts daily changes in equity allocations correlate only weakly with same day equity returns and do not correlate with future equity returns

are output fluctuations transitory according to the conventional view of the business cycle fluctuations in output represent temporary deviations from trend the purpose of this paper is to question this conventional view if fluctuations in output are dominated by temporary deviations from the natural rate of output then an unexpected change in output today should not substantially change one s forecast of output in say five or ten years our examination of quarterly postwar united states data leads us to be skeptical about this implication the data suggest that an unexpected change in real gnp of 1 percent should change one s forecast by over 1 percent over a long horizon

a news utility theory for inattention and delegation in portfolio choice recent evidence suggests that investors are inattentive to their portfolios and hire expensive portfolio managers this paper develops a life cycle portfolio choice model in which the investor experiences loss averse utility over news and can ignore his portfolio in such a model the investor prefers to ignore and not rebalance his portfolio most of the time because he dislikes bad news more than he likes good news such that expected news causes a first order decrease in utility consequently the investor has a first order willingness to pay a portfolio manager who rebalances actively on his behalf moreover the investor can diversify over time and his consumption aligns with predictions of mental accounting i structurally estimate the preference parameters by matching stock shares and stock market non participation over the life cycle my parameter estimates are in line with the literature generate reasonable intervals of inattention and simultaneously explain consumption and wealth accumulation over the life cycle here it matters that news utility preserves first order risk aversion even in the presence of stochastic labor income which also causes stock shares to rise in wealth

intertemporal preferences and labor supply in this paper the authors examine whether nonseparable preference structures ar e important in characterizing life cycle labor supply using longitud inal data on prime age males from the panel study of income dynamics they estimate a model of life cycle leisure and consumption under un certainty in which intertemporal preferences are allowed to be nonsep arable in leisure the model tests several alternative specifications considered in the literature they investigate the robustness of the ir findings to certain forms of population heterogeneity and types of model misspecification across alternative specifications the autho rs find that the standard assumption of intertemporally separable pre ferences for leisure is not consistent with the data copyright 1988 by the econometric society

portfolio inertia and stock market fluctuations this paper uses population wide data from the panel study of income dynamics and the survey of consumer finances to resolve the conflict between overtrading and inactivity shown in administrative data on brokerage and retirement accounts respectively considerable inertia is found and linked to characteristics e g limited education or resources but less to index movements the downswing has encouraged staying out rather than getting out of the market the small minority with brokerage accounts exhibits important differences in trading patterns relative to the population and invests small fractions of wealth in brokerage accounts results strengthen the case for default options in retirement accounts and built in trading provisions in mutual funds

life cycle portfolio choice with liquid and illiquid financial assets abstract traditionally quantitative models that have studied households portfolio choices have focused exclusively on the different risk properties of alternative financial assets we introduce differences in liquidity across assets in the standard life cycle model of portfolio choice more precisely in our model stocks are subject to transaction costs as considered in recent macroliterature we show that when these costs are calibrated to match the observed infrequency of households trading the model is able to generate patterns of portfolio stock allocation over age and wealth that are constant or moderately increasing thus more in line with the existing empirical evidence

capital mobility and asset pricing we present a model for the equilibrium movement of capital between asset markets that are distinguished only by the levels of capital invested in each investment in that market with the greatest amount of capital earns the lowest risk premium intermediaries optimally trade off the costs of intermediation against fees that depend on the gain they can offer to investors for moving their capital to the market with the higher mean return the bargaining power of an investor depends on potential access to alternative intermediaries in equilibrium the speeds of adjustment of mean returns and of capital between the two markets are increasing in the degree to which capital is imbalanced between the two markets and can be reduced by competition among intermediaries

individual investor perceptions and behavior during the financial crisis combining monthly survey data with matching trading records we examine how individual investor perceptions change and drive trading and risk taking behavior during the 2008 2009 financial crisis we find that investor perceptions fluctuate significantly during the crisis with risk tolerance and risk perceptions being less volatile than return expectations during the worst months of the crisis investors return expectations and risk tolerance decrease while their risk perceptions increase towards the end of the crisis investor perceptions recover we document substantial swings in trading and risk taking behavior that are driven by changes in investor perceptions overall individual investors continue to trade actively and do not de risk their investment portfolios during the crisis

time is money rational life cycle inertia and the delegation of investment management abstract many households display inertia in investment management over their life cycles our calibrated dynamic life cycle portfolio choice model can account for such an apparently irrational outcome by incorporating the fact that investors must forgo acquiring job specific skills when they spend time managing their money and their efficiency in financial decision making varies with age resulting inertia patterns mesh well with findings from prior studies and our own empirical results from panel study of income dynamics psid data we also analyze how people optimally choose between actively managing their assets versus delegating the task to financial advisors delegation proves valuable to both the young and the old our calibrated model quantifies welfare gains from including investment time and money costs as well as delegation in a life cycle setting

consequences of a commodity boom in a controlled economy accumulation and redistribution in kenya 1975 83 the economic theory of dutch disease is extended and applied to the 1976 79 coffee boom in kenya in this article when a commodity boom is perceived as temporary a large fraction will tend to be saved out of transient income the spending effect of the boom is supplemented by relative price changes resulting from capital stock increases in the presence of foreign exchange and import controls the benefits of a sudden export price increase may be transferred intersectorally using a general equilibrium model it is estimated that in kenya the benefits of the boom were largely transferred from coffee growers to urban groups

why do so few hold stocks the authors investigate why 75 percent of u s households do not hold stocks despite the equity premium and predictions of expected utility models the question is relevant for privatization asset pricing and tax progressivity issues they show that risk aversion per se heterogeneity of beliefs habit persistence time nonseparability and quantity constraints on borrowing do not account for the phenomenon a wedge between borrowing and lending rates and minimum investment requirements are plausible but empirically weak factors more promising explanations are inertia and departures from expected utility maximization there is also qualified support for nondiversifiable income risk as a contributing factor copyright 1995 by royal economic society

the simple dynamics of a debt crisis abstract optimal growth path of an impatient neoclassical economy is studied when creditors impose a credit ceiling to prevent debt repudiation the ceiling becomes binding in finite time when the credit constrained regime begins foreign capital inflows and domestic investment fall abruptly output per capita consumption and real wages gradually decline while the real interest rate rises these results show that debt crises in which high external debt is associated to low growth can occur even in the absence of unanticipated shocks policy mistakes or debt overhang effects if distortionary policies cause impatient behavior the model is consistent with chronic capital flight in the debtor country jel f34 f32

saving in developing countries theory and review in the literature on economic development much of the interest in saving has been focused on the relation between saving and growth but saving is not only about accumulation it is about smoothing consumption in the face of volatile and unpredictable income and helping to ensure the living standards of poor people whose lives are difficult and uncertain this paper develops a model of households which cannot borrow but which accumulate assets as a buffer stock to protect consumption when incomes are low such households dissave as often as they save do not accumulate assets over the long term and have on average very small asset holdings but their consumption is markedly smoother than their income much of the evidence is as consistent with this view of saving as it is incosistent with standard views of smoothing over the life cycle and with explanations of the link between saving and growth in terms of life cycle saving behavior consumption smoothing is also a useful way of thinking about government policy where volatility in the world prices of taxed commodities can generate sharp fluctuations in government revenues as well as reallocations of revenue between the private and public sectors many important policy issues in developing countries hinge on issues of consumption and smoothing and research on these issues is currently likely to be more productive than work on the relation between saving and growth

consumption smoothing and portfolio rebalancing the effects of adjustment costs abstract a household s response to income and return shocks depends on the costs of portfolio adjustment in particular the extent of portfolio rebalancing and consumption smoothing are influenced by the presence of non convex portfolio adjustment costs suppose bonds can be adjusted costlessly while adjustments to stock accounts entail adjustment costs due to these portfolio adjustment costs the household demands both stocks and bonds a household can buffer some income fluctuations without incurring adjustment costs and engage in costly portfolio rebalancing less frequently using the estimated preference parameters and portfolio adjustment costs the response to income and return shocks is nonlinear and reflects the interaction of portfolio rebalancing and consumption smoothing

information and inequality abstract this paper studies wealth inequality in a blanchard yaari model with idiosyncratic investment returns its key innovation is to assume that individuals can buy information information reduces uncertainty about the unknown mean investment return reduced estimation risk encourages investment in higher yielding risky assets as a result endogenous information acquisition amplifies wealth inequality wealthy individuals buy more information which leads them to invest a higher share of their wealth in higher yielding assets which then makes them even wealthier the model s empirical implications are studied using monte carlo simulations and perturbation approximations an empirically plausible decrease in information costs can explain about two thirds of the observed increase in the top 1 wealth share

till mortgage do us part mortgage switching costs and household s bank switching abstract we investigate the role of mortgage switching costs in shaping the households decision to change their main bank to this end we use a unique panel dataset that enables us to infer household s bank switching in conjunction with a legal reform that exogenously slashed down the mortgage switching costs the empirical evidence which survives to a variety of robustness checks supports the hypothesis that the explicit switching costs in the retail banking market are a weighty factor in shaping households bank switching despite any potential informational lock in dissecting the results we show that the effects of the reform were not uniform across households the more educated households those with a longer or broader relationship with their previous bank and those residing in ex ante less competitive banking markets were at the forefront of the wave of bank switching