Equity culture and household behavior

Abstract

Equity culture has spread among households on both sides of the Atlantic. We study likely effects of equity culture on the behavior of households entering the stock market. Without borrowing constraints, the improved prospects arising from the equity premium tend to dominate the increase in riskiness of future income streams. This encourages entrants to increase consumption, borrowing, and precautionary wealth accumulation, and to reduce net financial wealth. Wheather borrowing-constrained entrants will tend to increase consumption depends on risk aversion and on constraint tightness. Borrowing constraints can reduce, eliminate, or reverse the tendency of entrants to hold larger precautionary wealth buffers.