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Portfolio Choice and Liquidity Constraints

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  • Michael Haliassos
  • Alexandros Michaelides

Abstract

This paper generalizes Deaton's (1991) approach to saving under borrowing constraints to incorporate portfolio choice. For infinite horizon, impatient consumers, effects of risk aversion, prudence and temperance on portfolios can be different from those obtained in atemporal models. We confirm the surprising result of portfolio specialization in stocks (Heaton and Lucas, 1997) using a different earnings process, and we provide a rationale for why risk aversion and habit persistence cannot reverse it. We then show that positive correlation of stock returns with permanent, but not transitory, earnings shocks can generate demand for bonds and zero stockholding. However, existing empirical estimates of such correlations are at variance with portfolio data. We offer an alternative explanation of observed stock holding patterns based on fixed stock market entry costs. The entry cost required to keep impatient households out of the stock market is surprisingly small. This suggests that entry costs could generate the observed reluctance of households to undertake stockholding and explain the slowness in the emergence of an "equity culture" among households.

Suggested Citation

  • Michael Haliassos & Alexandros Michaelides, 1999. "Portfolio Choice and Liquidity Constraints," University of Cyprus Working Papers in Economics 9918, University of Cyprus Department of Economics.
  • Handle: RePEc:ucy:cypeua:9918
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    More about this item

    Keywords

    Precautionary Saving; Portfolio Choice; Liquidity Constraints; Buffer Stock;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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