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Who Becomes a Stockholder? Expectations, Subjective Uncertainty, and Asset Allocation
by Gábor Kézdi and Robert J. Willis
WP 2003-039
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We develop a model of portfolio selection with subjective uncertainty and learning in
order to explain why some people hold stocks while others don’t. We model
heterogeneity in information directly, which is an alternative to the existing explanations
that emphasized heterogeneity in transaction costs of investment. We plan to calibrate
the model to survey data (when available) on people’s perception about the distribution
of stock market returns. Our approach also leads to a model of learning with new
implications such as zero optimal risky assets, or ex post correlation of uncorrelated labor
income and optimal portfolio composition. It also points to two factors in probabilistic
thinking that should have a major impact on stock ownership. These are the level and the
precision of expectations. We construct proxy measures for the two parameters from the
1992-2000 waves of the Health and Retirement Study (HRS). We use a large battery of
the subjective probability questions administered in each wave of HRS to construct an
overall “index of optimism” (the correlated factor between all subjective probabilities)
and “index of precision” (the fraction of nonfocal probability answers, following Lillard
and Willis, 2001). We also construct measures for how people forecast the weather, their
cognitive capacity, wealth, and basic demographics. Our results indicate that stock
ownership and the probability of becoming a stockholder are strongly positively
correlated with the indices of the level and precision of expectations. Interpretation of
the former is quite challenging and further research is needed to understand its full
content.
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