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RFS Advance Access published online on April 13, 2007
Review of Financial Studies, doi:10.1093/rfs/hhm022
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Copyright © The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies.

The Forgone Gains of Incomplete Portfolios

Monica Paiella*
* Bank of Italy, Research Department, Via Nazionale 91, Rome 00184, Italy, tel. +39.06.4792.2595, fax. +39.06.4792.3723

monica.paiella{at}bancaditalia.it

This paper proposes a test for the cost-based explanation of non-participation, by estimating a lower bound to the forgone gains of incomplete portfolios; these are in turn a lower bound to the costs that could rationalize non-participation in financial markets: high bounds would imply implausibly high costs. Assuming isoelastic utility and a relative risk aversion of 3 or less, for the stock market I estimate an average lower bound of between 0.7 and 3.3 percent of consumption. Since total annual (observable plus unobservable) participation costs are likely to exceed these bounds, the cost-based explanation is not rejected by this test.


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