The field of household finance is confronted with the phenomena called “stock market participation puzzle” (Haliassos, 2003) which describes that most households do not hold stocks, despite that there are higher expected returns on stocks than on risk free assets (Haliassos, 2003). According to Haliassos and Bertaut (1995), 75% of households in the United States do not own stocks directly although returns on equity exceed the returns on risk free assets. This issue does not only concern households themselves, financial intermediaries, and stock issuers. It is also relevant for questions concerning privatisation, asset pricing, and tax rates on capital gains (Haliassos and Bertaut, 1995). The participation rate can directly affect the equity premium as argued by Mankiw and Zeldes (1991), and Heaton and Lucas (1999).
Stock market participation in this seminar thesis refers to households participating in the market by holding stocks, excluding retirement accounts. The purpose is to demonstrate five factors discussed in financial literature that contribute to solve the stock market participation puzzle or reasons why limited stock market participation can be observed: Deviation from standard expected utility (Haliassos, 2003; Epstein and Zin, 1990; Haliassos and Hassapis, 1999; Diecidue and Wakker, 2001; Haliassos and Bertaut, 1995), more restricted borrowing constraints (Constantinides, Donaldson, and Mehra, 2002; Cocco, Gomes, and Maenhout, 2005; Haliassos, 2003), participation and entry costs (Guiso and Japelli, 2004; Gollier, 2002; Haliassos and Michaelides, 2003; Paiella, 2001; Vissing-Jorgensen, 2002; Haliassos, 2003), lack of financial awareness (Guiso and Jappelli, 2004), and financial illiteracy (van Rooij, Lusardi, and Alessie, 2007; Arrondel, Debbich, and Savignac, 2012; King and Leape, 1987).
Table of Contents
1 Introduction
2 What Theory predicts about Households Stockholding Decision
3 Contributions to Explain Limited Stock Market Participation
3.1 Deviation from Standard Expected Utility
3.2 More Restricted Borrowing Constraints
3.3 Participation and Entry Costs
3.4 Lack of Financial Awareness
3.5 Financial Illiteracy
4 Achieve More Stock Market Participation
4.1 Advertisement
4.2 Targeted Financial Education
4.3 Cost Reduction
5 Conclusion
Research Objectives and Themes
This seminar thesis examines the "stock market participation puzzle," which highlights the empirical observation that most households do not hold stocks despite higher expected returns compared to risk-free assets. The research aims to identify and analyze five key factors in the financial literature that explain this limited participation, while evaluating potential strategies to increase stock market engagement among households.
- Theoretical deviations from standard expected utility models.
- Impact of borrowing and short-sale constraints on participation.
- Role of entry and participation costs as market hurdles.
- Influence of financial awareness and general financial literacy.
- Effectiveness of policy interventions such as advertising and education.
Excerpt from the Book
3.1 Deviation from Standard Expected Utility
From section two, neither any kind background risk faced by the household, nor the risk attitude can be a reason for the decision not to participate in the stock market (Haliassos, 2003, p. 33). So risk aversion itself, defined by the curvature of the utility function (Haliassos and Hassapis, 1999, p. 8), cannot explain zero stockholding (Haliassos, 2003, p. 33).
Haliassos and Hassapis (1999) present how departures from standard expected utility models, using non-expected utility that exhibits a different kind of risk-aversion, can serve to answer why stockholding is so limited. Their focus is on the “rank-dependent utility” (Haliassos and Hassapis, 1999, p. 6) which exhibits “first-order risk aversion” (Haliassos and Hassapis, 1999, p. 6). The basic idea is that inclusion of outcome ranking can lead to zero stockholding. Consider a household that ranks outcomes from worst outcome to best. The ranking of the outcomes again depends on the households’ actions. High returns are assessed as good when the household takes a long position on stocks. When the household can short stocks high returns are assessed as bad. Outcomes are equally ranked when stockholding is zero (neither long nor short). At this point the objective function alters (because preferences change) resulting in “non-differentiability” (Haliassos and Hassapis, 1999, p. 7) of the objective function. This means that first-order conditions cannot be used as usual to derive the optimal solution. The respective indifference curves exhibit a “kink” (Haliassos and Hassapis, 1999, p. 7). For a household with zero stockholding the kink can result in preferring zero stockholding to either a long or short position (Haliassos and Hassapis, 1999, p. 6-9). This is because the trade-off between risk and return at zero stockholding is not perceived as smooth (Haliassos and Bertaut, 1995, p. 1120). In other words, the household sticks at the point where a reversal in outcome ranking takes place which means it sticks at zero stockholding because this is the reversal point of outcome ranking (Haliassos, 2003, p. 34-35).
Summary of Chapters
1 Introduction: Provides an overview of the stock market participation puzzle and outlines the five primary factors that contribute to limited household stockholding.
2 What Theory predicts about Households Stockholding Decision: Discusses how standard financial models assume all households should hold stocks if risk-averse and returns on risky assets are positive.
3 Contributions to Explain Limited Stock Market Participation: Analyzes specific market and behavioral factors, including utility deviations, borrowing constraints, entry costs, and literacy gaps.
4 Achieve More Stock Market Participation: Evaluates practical measures to increase participation, such as advertising, targeted education, and the reduction of entry costs.
5 Conclusion: Summarizes the theoretical and empirical findings, emphasizing that multifaceted strategies are required to bridge the gap in market participation.
Keywords
Stock market participation, Household finance, Equity premium, Expected utility, Borrowing constraints, Entry costs, Financial literacy, Financial awareness, Portfolio choice, Risk aversion, Asset pricing, Investment behavior, Financial education, Advertising, Wealth effect.
Frequently Asked Questions
What is the core subject of this thesis?
The thesis explores the "stock market participation puzzle," describing why a significant majority of households choose not to invest in the stock market despite the potential for higher returns compared to risk-free assets.
What are the primary themes discussed?
Key themes include theoretical explanations for non-participation, the impact of market frictions like borrowing constraints and entry costs, and the roles of behavioral factors such as financial literacy and awareness.
What is the primary goal of the study?
The primary goal is to categorize and evaluate five key factors derived from financial literature that contribute to the participation puzzle and to propose solutions for increasing household stock ownership.
Which scientific methods are primarily utilized?
The thesis conducts a literature review and synthesis of existing empirical studies and theoretical models, focusing on data and findings from influential research papers within the field of household finance.
What is addressed in the main body?
The main body systematically reviews why standard theoretical assumptions fail to predict household behavior, analyzes specific obstacles like "rank-dependent utility" or "financial illiteracy," and suggests policy-based solutions like financial education and cost reduction.
What keywords characterize the work?
Key terms include stock market participation, household finance, financial literacy, entry costs, borrowing constraints, and equity premium.
How does rank-dependent utility explain non-participation?
It suggests that preferences can exhibit "first-order risk aversion," where a household encounters a "kink" in its utility function at zero stockholding, making it optimal to avoid both long and short positions.
What is the role of entry costs in this context?
Entry costs serve as a financial hurdle. For households with low wealth or high impatience, the benefits of participating in the market do not overcompensate for these costs, leading to rational non-participation.
Why is financial literacy considered a critical factor?
Evidence shows that higher financial literacy is strongly correlated with stock ownership. Low financial knowledge prevents households from understanding investment opportunities and managing risks, which negatively affects participation.
Can advertising effectively change household behavior?
Yes, empirical evidence suggests that increased advertising and permanent information flows can improve awareness and familiarity, thereby encouraging households to enter and remain in the stock market.
- Arbeit zitieren
- Adrian Schmid (Autor:in), 2014, Stock Market Participation, München, GRIN Verlag, https://www.hausarbeiten.de/document/494290
