Stock market participation and macro-financial trends

This paper documents a puzzle for canonical limited-participation models: when U.S. stock market participation rose from 31.6% to 53% between 1989 and 2007—a period also characterized by the Great Moderation—the equity premium and stock return volatility increased rather than fell as those models would predict. The paper resolves this puzzle using an RBC model with concentrated capital ownership in which capitalists have external habit utility with a habit stock that depends on aggregate per capita consumption. As participation rises, the representative capitalist’s consumption converges to aggregate consumption, shrinking the surplus-consumption ratio and raising endogenous average risk-aversion; this risk-aversion channel dominates the conventional risk-sharing channel (which predicts a lower equity premium under higher participation). The model implies that higher participation generates a sizeable rise in both the equity premium and stock return volatility while reducing the risk-free rate and aggregate consumption volatility—jointly explaining the observed U.S. macro-financial patterns. Household-level data from the Consumption Expenditure Survey (1984–2017) and cross-state variation support the model’s mechanism.

Francesco Saverio Gaudio | Macro Paper Warehouse

Stock market participation and macro-financial trends