Who Becomes A Stockholder? Expectations, Subjective Uncertainty, and Asset Allocation

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. Our approach leads to a model of learning with new implications such as zero optimal risky assets, or ex post correlation of income or wealth 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 stock market expectations. We use subjective proxy measures of expectations from the Health and Retirement Study (HRS) over stock returns and economic growth. We also use an index of precision over many subjective probabilities from the 1992-2002 waves of HRS, a measure introduced by Lillard and Willis (2001). 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. They also significantly reduce the partial correlation of stock ownership and education, race and wealth, which indicates that the latter are probably at least as much proxies for expectations and probabilistic thinking as measures of direct transaction costs. The research herein was performed pursuant to a grant from the U.S. Social Security Administration (SSA) to the Michigan Retirement Research Center. Additional support was received by the second author from NIA grant P0-1 AG10179. Data from the Health and Retirement Study used in this paper were funded by the National Institute on Aging with additional support from SSA.