Consumption Smoothing and Portfolio Rebalancing: The Effects of Adjustment Costs

This paper studies the dynamics of portfolio rebalancing and consumption smoothing in the presence of non-convex portfolio adjustment costs. The goal is to understand a household's response to income and return shocks. The model includes the choice of two assets: one riskless without adjustment costs and a second risky asset with adjustment costs. With these multiple assets, a household can buffer some income fluctuations through the asset without adjustment costs and engage in costly portfolio rebalancing less frequently. We estimate both preference parameters and portfolio adjustment costs. The estimates are used for evaluating consumption smoothing and portfolio adjustment in the face of income and return shocks.

Essays in dynamic household finance with heterogeneous agents

textTwo central themes in asset pricing theory are how averse households are to taking on risks, and how willing they are to substitute consumption over time in response to the incentives provided by asset returns. These issues are central to understanding both asset returns and consumption patterns. Most work in this field operates on the basic observation that not all households invest in the stock market. Studies that account for market segmentation assume that all stockholders hold a financial index (S&P, NYSE) and use one of these indexes as a proxy for household-specific portfolio. According to the latest data from the 2004 Survey of Consumer Finances, however, the median US stockholders who own stocks directly hold only 3 stock securities. Another data observation from the SCF (and other sources) is that stockholders with different wealth levels have different returns on their stocks. These data observations call into question the validity of financial index as a proper proxy for household-specific portfolio. This research starts from the two basic observations that most stockholders hold only a few individual stocks and stockholders with different wealth levels have a different rate of return on their stocks. If a large fraction of households do not hold a financial index, then how does that affect our inference about households' willingness to substitute consumption over time for the incentives provided by asset returns and to accept risks? Furthermore, what does it teach us about what a good model of assets prices looks like? And why do households hold only a few individual stocks? My research addresses these issues. Specifically, in the first chapter I study the heterogeneity in households' portfolio choice and performance and find that the tradeoffs between average payoffs and risk alone cannot explain heterogeneity in portfolio returns. In the second section, I address a long-standing question in macroeconomics and finance- the value of the risk aversion for households with different wealth levels. In the third chapter, I study the effect of political affiliation on portfolio choice.Economic

Why do Wealthy Investors have a Higher Return on their Stocks?

In contrast to the standard economics theory, an analysis of the Survey of Consumer Finance shows that wealthy investors have a higher return on their stocks than their poorer counterparts. The paper presents a general financial and economic theory of risk and search behavior to address the question if why wealthy investors have a higher return on their stocks. Two additional facts emerge: (i) wealthy investors employ more productive search efforts, and (ii) financial risk bearing and search efforts are complementary. This study develops an explanation for the wealth inequality and the equity premium puzzle as well as the policy implications of the privatization of social securityInvestment decisions, financial behavior, search and risk behavior

Costly Portfolio Adjustment

This paper studies the dynamic optimization problem of a household when portfolio adjustment is costly. The analysis is motivated by the observation that on a monthly basis, less than 10% of stockholders typically adjust their portfolio of common stocks. We use this, and related observations, to estimate the parameters of household preferences and portfolio adjustment costs. We find significant adjustment costs, beyond the direct costs of buying and selling assets. These adjustment costs imply that inferences drawn about household risk aversion and the elasticity of intertemporal substitution are biased: household risk aversion is lower compared to other estimates and it is not equal to the inverse of the elasticity of intertemporal substitution

A new “Wall Street Darling?” effects of regulation sentiment in cryptocurrency markets

•We analyze the prospect of cryptocurrency regulation affects cryptocurrency prices, volatility and trading.•We use Google Trend technique to construct the Crypto Regulation Sentiment Index (CRSX).•CRSX is reflecting investors’ attitude towards Crypto regulation: globally and for the US.•We find CRSX has no statistically significant long-term impact on cryptocurrency prices.•Our finding is consistent with investors having overly positive attitudes towards crypto assets, making crypto a “Wall Street Darling”.•CRSX has a large impact on cryptocurrency price volatility and trading volume.•The effects of CSRX on crypto markets largely depends on the coin's key blockchain characteristics. We analyze the prospect of cryptocurrency regulation affects cryptocurrency prices, volatility and trading using the Google Trend technique to construct the Crypto Regulation Sentiment Index (CRSX) reflecting investors’ attitude towards Crypto regulation. Our analysis encompasses over 75% of the crypto market's daily activity. We find CRSX has no statistically significant long-term impact on cryptocurrency prices, consistent with investors having overly positive attitudes towards crypto assets, making crypto a “Wall Street Darling”. Nonetheless, CRSX has a large impact on cryptocurrency price volatility and trading volume. The effects of CSRX on crypto markets largely depends on the coin's key blockchain characteristics

Rationalizing Trading Frequency and Returns

Barber and Odean (2000) study the relationship between trading frequency and returns. They find that households who trade more frequently have a lower net return than other households. But all households have about the same gross return. They argue that these results cannot emerge from a model with rational traders and instead attribute these findings to overconfidence. Using a dynamic optimization approach, we find that neither a model with rational agents facing adjustment costs nor various models of overconfidence fit these facts

Political activism, information costs, and stock market participation

This paper examines whether political activism increases people's propensity to participate in the stock market. Our key conjecture is that politically active people follow political news more actively, which increases their chance of being exposed to financial news. Consequently, their information gathering costs are likely to be lower and the propensity to participate in the market would be higher. We find support for this hypothesis using multiple micro-level data sets, state-level data from the US, and cross-country data from Europe. Irrespective of their political affiliation, politically active individuals are 9–25% more likely to participate in the stock market. Using residence in “battleground” states and several other geographic instruments, we demonstrate that greater political activism reduces information gathering costs and causes higher market participation rates. Further, consistent with our conjecture, we find that politically active individuals spend about 30 minutes more on news daily and appear more knowledgeable about the economy and the markets