Sunday, February 26, 2012

The participation puzzle is worse that I thought!

In an interesting paper recently published in the Journal of Finance (and discussed by Bob Shiller in today's NYT), GRINBLATT, KELOHARJU, and LINNAINMAA investigate the effects of IQ on stock market participation in Finland (ungated version of the paper is here).

 As they point out, "Only about 50% of U.S. households invest in stocks, either directly or indirectly (via mutual funds in retirement and nonretirement accounts), and participation in Europe is even lower. Traditional models in financial economics, which prescribe universal participation, cannot easily explain these stylized facts, viewing them as a “participation puzzle.”"

 But IQ is not solving this puzzle at all (at least in Finland)!

 The two highest stanines of IQ in their sample have stock market participation rates of around 42% and 46% respectively. Sure, that is significantly higher than the lower IQ groups, but their research shows that, even among the most sophisticated citizens, stock market participation is very low.

 The paper is very well done and highly recommended, but I was amazed that participation among even the elites was so low.


5 comments:

Paul Gowder said...

Being totally unfamiliar with the participation puzzle literature, I'd guess that close to 100% of the explanation is a combination of information costs (abt investing strategies as well as the skill of professional investors), risk aversion, and wealth effects (i.e., most of those in the bottom half of the income distro have enough trouble maintaining positive net wealth, let alone investing). But I'm sure the literature has already explained why that intuition is wrong... got any cites?

Angus said...

Hi Paul: Decent lit review in the paper I linked to, and I agree with what you are saying, but my surprise is even the high IQ high wealth Finns averaged only 46% stock market participation. And that counts ANY participation.

Tom said...

Perhaps IQ does not measure what you think it measures.

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