nr 040 - Stock market optimism and participation cost: a mean-variance estimation

DNB Working Papers
Date 27 May 2005
This paper estimates the costs of participating to the stock market, together with the cross sectional dispersion of stock market optimism. Our analysis is based on a mean-variance framework, when there is a riskless asset (cash), which makes the allocation of the investment in risky assets (stocks and bonds) independent on preferences. Within this framework, we derive “structural” decision rules for the composition of the risky asset portfolio to be e¢cient. These rules depend on the amount invested in the risky portfolio and on investors’ optimism, which are the determinants of the stock market return expected by a household, when participation involves a …xed cost. Using these rules and the heterogeneity in risky assets holdings and in the degree of optimism, we identify both the fixed costs of stock investment and the variance of optimism. Using the Italian Survey of Household Income and Wealth we find that the risky asset portfolios of Italian households are coherent with a fixed cost of participating to the stock market around 150 euros per year (0.9% of non-durable expenditure). Having a university degree, owning one’s home and living in the North of the country contribute to lower the cost. The standard deviation of investors’ optimism is estimated to be high, at around 30 percent. JEL: D12, D14, G11 Keywords: heterogeneous household portfolios, mean-variance frontier, participation cost, expectation error