Awareness and Stock Market Participation

Transcription

1 WORKING PAPER NO. 110 Awareness and Stock Market Partcpaton Lug Guso and Tullo Jappell November 2003 Ths verson June 2004 Unversty of Naples Federco II Unversty of Salerno Boccon Unversty, Mlan CSEF - Centre for Studes n Economcs and Fnance UNIVERSITY OF SALERNO FISCIANO (SA) - ITALY Tel / Fax e-mal: csef@unsa.t

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3 WORKING PAPER NO. 110 Awareness and Stock Market Partcpaton Lug Guso * and Tullo Jappell ** Abstract The extent to whch consumers are aware of avalable fnancal assets depends on the ncentves of asset supplers to spread nformaton about the nstruments they ssue. We propose a theoretcal framework n whch the amount of nformaton dssemnated and the probablty of ndvduals becomng aware of fnancal assets are correlated wth the probablty that, once nformed, they wll nvest n the asset and negatvely affected by the cost of spreadng nformaton. Socal learnng s a further channel through whch potental nvestors may come to be nformed about exstng assets. Whle socal learnng may lmt the producton of fnancal nformaton by assets supplers, t ncreases the probablty that ndvduals become fnancally aware. These predctons are supported by data on awareness of fnancal assets avalable n the 1995 and 1998 waves of the Italan Survey of Household Income and Wealth. Lack of fnancal awareness has mportant mplcatons for understandng the stockholdng puzzle and for estmatng stock market partcpaton costs. Keywords: fnancal nformaton, portfolo choce. JEL Classfcaton: E2, D8, G1. Acknowledgments: Work supported n part by the European Communty s Human Potental Programme under contract HPRN-CT (AGE). We also acknowledge fnancal support from the Italan Mnstry of Educaton, Unverstes and Research (MIUR). We thank Raffaele Mnac and semnar partcpants at the Bank of Italy, the Unversty of Padua, the Unversty of Vence, and the Unversty of Salerno for helpful comments. * ** Unversty of Sassar, Ente Lug Enaud for Monetary, Bankng and Fnancal Studes, and CEPR CSEF, Unversty of Salerno and CEPR

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5 Table of contents 1. Introducton 2. The theoretcal framework 2.1. Awareness 2.2. Socal learnng 3. Measurng fnancal awareness 4. The determnants of fnancal awareness 4.1. Descrptve evdence 4.2. Econometrc analyss 5. Implcatons 5.1. The stockholdng puzzle 5.2. Partcpaton costs 6. Conclusons Reference

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7 1. Introducton The classcal theory of portfolo choce rests on strong assumptons: no transacton costs, nvestors awareness of the full menu of assets avalable and knowledge of ther rsk and return, no unnsurable rsks, such as human captal. If all nvestors face the same dstrbuton of returns and have the same nformaton set, n equlbrum they select the same menu of rsky assets. Dfferences n atttudes to rsk affect the allocaton of wealth between safe and rsky assets, but not the partcular asset selected. And f the utlty functon has constant relatve rsk averson, asset shares are ndependent of wealth. Under these assumptons, the rch man s portfolo s smply a scaled-up verson of that of poor man s. However recent emprcal studes have shown that household portfolos exhbt far too much heterogenety to be consstent wth ths sort of unformty. In partcular, many ndvduals smply do not nvest n stocks, a feature that has come to be known as the stockholdng puzzle. Fxed entry costs have been the man thess n the lterature to resolve the puzzle. Wth entry costs, nvestors beneft from stock market partcpaton only f the (certanty equvalent) expected excess return from partcpaton exceeds the fxed cost. Snce the gan ncreases wth wealth, entry costs make strong predctons about the relaton between wealth and the probablty of nvestng n stocks. In partcular, nvestors wth wealth below a certan threshold do not enter the stock market, those above t do. Emprcal evdence n Guso, Halassos and Jappell (2003) documents a strong postve correlaton between stock market partcpaton and household fnancal wealth n many ndustralzed countres, supportng the entry costs thess. 1 But there s also the nternatonal evdence that many affluent households do not nvest n stocks whch suggests that other forces than entry costs alone may be at work. Furthermore, the entry cost lterature does not explan the orgn and nature of these costs. Yet understandng what nhbts stock market partcpaton s crucal for polces amed at encouragng portfolo dversfcaton and spreadng the equty culture. In ths paper we call attenton to nformaton costs and barrers as an explanaton for the 1 The evdence s based on detaled mcroeconomc data for France, Germany, Italy, the Netherlands, Sweden, the Unted States and the Unted Kngdom. 7

8 stockholdng puzzle. The barrer we consder s awareness of the menu of assets avalable, and partcularly of stocks, mutual funds and the lke. In a semnal paper, Merton (1987) related portfolo ncompleteness and heterogenety to lack of nformaton on nvestment opportuntes, callng attenton to the ndsputable fact that nvestors purchase only securtes they know about. Merton showed that even n the absence of monetary transacton costs, portfolo choce depends on the partcular asset menu known to each nvestor. So, qute obvously, lack of awareness s a complementary explanaton for the stockholdng puzzle. The queston then becomes how mportant s awareness n practce? We use a recent survey of Italan households wth detaled data on awareness of fnancal assets. The survey uncovers consderable lack of basc fnancal nformaton: 35 percent of potental nvestors are not aware of stocks, and 50 percent of mutual funds. The magntude of these numbers suggests that asset awareness mght be of frst order mportance n determnng portfolo selecton. One could argue that snce potental nvestors could obtan nformaton by spendng resources on fnancal advce, such explanatons of the stockholdng puzzle are ndstngushable from those based on entry costs. But ths s ncorrect. Suppose an ndvdual could obtan a lst of all avalable assets at a fxed cost. To be able to choose whether t s worthwhle to pay the fxed cost and receve the lst or nvest only n the assets of whch he s already aware, he would have to be able to compute the benefts of knowng the lst before buyng t. But ths mples that he must already be aware of the exstence of the assets (and of ther rsk and return) before payng the cost. In other words, awareness s not a choce varable, but exogenous wth respect to ndvdual choce. What, then, does explan asset awareness? Why do some ndvduals know about some assets and others not? And what are the mechansms through whch ndvduals become aware? As Merton (1977) ponts out, awareness affects asset prces because those that are less wdely known, and thus less commonly selected, pay a premum. Ths makes t worthwhle for frms to nvest resources n spreadng nformaton about ther own stocks, suggestng one possble avenue through whch nvestors gan awareness. When assets are not dstrbuted drectly by frms, fnancal ntermedares and asset dstrbutors have a smlar ncentve to nform, because profts ncrease wth the number of adopters. In ths paper we generalze these deas, confront them wth the data and provde evdence on the determnants of fnancal awareness. We present a smple framework to 8

9 analyze the seller s decson on the number of sgnals to send to potental nvestors. Both the producton of sgnals and asset purchase, once nvestors become aware of t, are costly. In prncple, lack of awareness can explan the stockholdng puzzle even wthout entry costs. However, our model shows that awareness and entry costs nteract, wth addtonal nterestng nsghts. Entry costs do not just lmt nvestors opportunty set drectly; they also dscourage fnancal ntermedares from nformng potental nvestors. When entry costs are hgh, there s lttle ncentve to ncur the cost of nformaton because purchase remans unlkely. So a reducton n entry costs affects stockholdng two ways: drectly, as more people purchase stocks, and ndrectly as the ncentve to nform potental nvestors s greater, whch n turn ncreases the number of aware nvestors and ther market partcpaton. Learnng from fnancal ntermedares s just one of way that people become aware of nvestment opportuntes. Many learn from other ndvduals through socal nteracton, whch s another channel for spreadng the equty culture. Hence, we extend our framework to allow for socal learnng, and show that socal nteracton ndeed ncreases the probablty that ndvduals become fnancally aware. However, we also show that, dependng on parameter values, more ntense socal nteracton may nduce asset supplers to rely on word-of-mouth rather than drect nformaton producton, thus savng on nformaton dssemnaton costs. Besdes Merton s paper and the lterature on the stockholdng puzzle, our work s related to three further strands of the lterature: fnancal nformaton, socal learnng, and advertsement. Grossman and Stgltz (1980) and Verreccha (1980) examned how nformaton on asset returns affects portfolo choce. In these models dfferences among nvestors are endogenous, and fnancal nformaton reduces subjectve uncertanty on returns. Wealther nvestors beneft more from fnancal nformaton and are therefore better nformed. Peress (2004) studes stock market partcpaton n ths framework allowng also for fxed entry costs. 2 In contrast to our approach, these papers assume that nvestors are aware of all avalable assets but can acqure nformaton, mprovng the precson of ther subjectve expectatons of asset returns, whereas n our framework potental nvestors cannot choose to become aware. The recent lterature on portfolo choce and socal nteractons sgnals, as an mportant 2 Peress shows that three types of nvestors coexst n equlbrum. Poor nvestors do not buy stocks and are not nformed. For ntermedate levels of wealth, nvestors buy stocks but choose to reman unnformed. Rch nvestors choose to buy stocks and to acqure nformaton. That s, stock market partcpaton and the amount of nformaton ncrease wth wealth. 9

10 channel of accumulaton of fnancal nformaton, the exchange of opnons among frends and peers and that nvestors have a preference for famlar frms. Duflo and Saez (2002), for nstance, fnd that partcpaton n penson plans s affected by one s peers choces, and Hong, Kubk and Sten (2004) show that socal nteractons promote nvestment n stocks. Grullon, Kanatas and Weston (2004) provde emprcal evdence that famlarty wth the frm affects nvestors behavor. Specfcally, they measure a frm s overall vsblty wth nvestors by ts product market advertsng, and show that frms wth greater advertsng expendtures have a larger number of ndvduals and nsttutonal nvestors, and better lqudty of ther stocks. 3 One way to explan these fndngs s that socal ndvduals have lower nformaton costs. Rather than nferrng the role of socal learnng from the stock market partcpaton decson, we are able to provde a drect test of the effect of socal learnng on awareness, thus provdng mportant nsghts nto the mechansm by whch socal learnng affects stockholdng. 4 But we also pont out that socal nteractons can lmt asset supplers ncentve to produce costly nformaton, because market partcpants can rely also on nformaton collected and (freely) passed over by others through socal contacts. Fnally, the paper s related to the ndustral organzaton lterature on advertsement, as summarzed by Trole (1989). Our emprcal analyss consders that lterature s pont that the ncentves to dssemnate nformaton are affected by market structure. The remander of the paper s organzed as follows. Secton 2 presents a smple theoretcal framework on nformaton producton and dssemnaton. Secton 3 descrbes the data and the ndcators of fnancal awareness. Secton 4 tests the basc mplcatons of the model of fnancal awareness, wth specal focus on the effect of household characterstcs, costs of nformaton producton, and socal learnng. Secton 5 explores the mplcatons of awareness for the stockholdng puzzle and for the estmaton of entry costs. We frst compute the probablty of nvestng n stocks and other rsky assets n a sample of aware nvestors. We then mpute the probablty on a sample of unaware nvestors and estmate the quanttatve 3 In a related paper, Grnblatt and Keloharju (2001) document that dstance, language and culture explan patterns of stockholdng n Fnland, and that nvestors are more lkely to buy and sell stocks of companes that are close to the nvestor's locaton, that communcate n the nvestor s natve tongue and that have chef executves of the same cultural background. 4 Socal nteractons may ncrease stockholdng not only because socal ndvduals may become better nformed, but also because socal nteracton enhances trust n others, ncludng brokers and funds managers, as suggested by Guso, Sapenza and Zngales (2004). 10

11 mpact of awareness on stockholdng. There s evdence that falure to consder the awareness factor leads to overestmaton of partcpaton costs. Secton 6 summarzes the results. 2. The theoretcal framework We argued n the ntroducton that awareness of the exstence of stocks (or, for that matter, any fnancal asset) s exogenous to the nvestor s choce set. But then, how s t that some nvestors are aware of a wde menu of fnancal assets, others only a small set of nvestment opportuntes? And how do ndvduals come to know about fnancal assets? Here we address these questons, snglng out some of the key determnants of awareness and obtanng predctons that can be tested emprcally. Lke Merton (1987), we stress that ssuers and dstrbutors of fnancal assets have strong ncentves to nform the pool of potental nvestors; broadenng the nvestor base lowers the cost of rasng external captal for ssuers and ncreases revenues for dstrbutors Awareness Although the analyses apples equally well to any fnancal asset, we focus on stocks. Let b denote the unt proft from ncreasng the stockholder base by one unt. There are N potental nvestors. The expected beneft for the ssuer s the product of unt proft b and the expected amount nvested n stocks: bp ( I) p( A I) an, where p(i) denotes the probablty that an nvestor s aware of the stock, p(a I) the probablty that he wll buy the stock, condtonal on knowng about t, and a the average amount nvested by those buyng the stock. We assume that entry costs affect the partcpaton decson, so that not all nvestors buy stocks and p(a I)<1. 5 As we shall see, one mplcaton of ths assumpton s that entry costs affect the ssuer s ncentve to nform potental nvestors. If ssuers are able to sort potental nvestors nto groups wth smlar characterstcs the 5 In the standard portfolo model wth no entry costs, p(a I)=1, and only those who are not aware of stocks do 11

12 analyss can be thought of as applyng to one of these groups. Even though for smplcty we do not keep track of the group ndex, note that f potental nvestors are sorted nto smlar groups, p ( A I) a wll dffer across groups and depend on ther characterstcs. Issuers and dstrbutors can broaden the nvestor base by dssemnatng nformaton about ther stocks, by such means as malngs, advertsng n the fnancal press or drect contacts wth potental nvestors. Let S denote the number of nformaton sgnals, contacts or ads sent. The probablty that an nvestor receves the sgnal and becomes aware ncreases wth the number of sgnals. However, some nvestors may never receve a sgnal even f the number of sgnals s very large, because the nformaton technology never reaches them (for nstance, they don t read newspapers and have no contacts wth fnancal ntermedares). The followng functon of the probablty of recevng a sgnal captures ths possblty: S / N p( I) = (1) β + S / N Equaton (1) posts that the probablty of recevng a sgnal ncreases wth the number of sgnals per potental nvestor, S/N. The parameter β>0 measures the effcency of the nformaton technology. A lower value of β mples that a gven number of sgnals entals a larger P(I). As the number of sgnals approaches nfnty, P(I) converges to 1, the faster the lower s β. But for fnte number of sgnals, P(I) < 1. Producng a sgnal costs c euros to the ssuer, who chooses the number of sgnals n order to maxmze profts: 6 S / N max { S } π ( S) = bp( A I) an cs S N (2) β + / s. t. S 0 From the frst order condton of the problem, one obtans: not buy them. 6 If potental nvestors are sorted n K groups, the ssuer chooses the number of sgnals for each group maxmzng total profts: Sk / Nk max { S Sk bpk A I ak Nk cs k } π ( ) = ( ) k, k β + Sk / Nk where k=1, K denotes a partcular group of potental nvestors. From the frst order condtons one obtans an 12

13 S βbp( A I) a = N c β (3) The optmal number of sgnals falls wth the cost of a sgnal and ncreases wth the probablty of buyng condtonal on recevng the sgnal and beng aware, and wth the average amount nvested by buyers. If the latter s too small, ssuers may not send any sgnal, because too few nvestors would buy even f they receved the sgnal. Ths wll occur f βc P( A I) a. b The pont here s that entry costs and awareness nteract. Lower entry costs affect stock market partcpaton drectly, encouragng aware nvestors to buy. But they can also ncrease partcpaton ndrectly, because ssuers fnd t more proftable to send sgnals when they have a strong mpact on the stockholder base, whle f entry costs are so hgh as to dscourage most nvestors from buyng, ssuers wll be less wllng to spend on advertsng. Substtutng equaton (3) nto (1), we obtan an expresson for the probablty of recevng a sgnal and beng aware: 1 p( I) = 0 βc bp( A I) a f f P( A I) a βc / b P( A I) a < βc / b (4) The probablty of becomng nformed s an ncreasng functon of the probablty of buyng stocks (f aware) and a decreasng functon of the cost of the sgnal. These are neat emprcal predctons whch wll be confronted wth the data n Secton 4. expresson smlar to equaton (3) n the text for each group. 13

14 2.2. Socal learnng Besdes learnng from sgnals and contacts wth ssuers and dstrbutors, ndvduals often learn about nvestment opportuntes from peers who have been nformed by fnancal ntermedares. Socal learnng changes dstrbutors ncentves and hence the optmal sgnal polcy. How ths occurs depends on the specfc process of socal learnng and on how people nteract. The smplest case s one n whch each potental nvestor nteracts sequentally wth another nvestor. Suppose that ndvdual has a probablty 0<δ<1 of meetng ndvdual +1. The probablty δ ncreases wth the strength of socal networks and exchange n a communty. If +1 s aware, then also becomes aware. Thus, can become aware f he receves a sgnal wth probablty gven n equaton (1) whch we denote s here or because he does not receve a sgnals, whch occurs wth probablty 1 s, but meets +1, provded +1 s aware. In turn, +1 s aware wth probablty s gven agan by (1) or because he does not receve a sgnal but meets and learns from +2 wth probablty δ, provded agan +2 s aware. Thus, the probablty that s aware s: p S / N β I) = s + (1 s) δ p+ 1( I) = + ( ) δp ( I) (5) β + S / N β + S / N ( + 1 Repeated substtuton gves: p s S / N ( I) = = 1 δ (1 s) β (1 δ ) + S / N (6) whch s bounded between zero and 1. Note that, for gven s, the probablty of beng aware s larger wth socal learnng than wthout socal learnng. In fact 1/ [ 1 (1 s) ] δ = µ >1 s the socal learnng multpler. Socal learnng amplfes the effectveness of a gven sgnal, whch thus has a better chance of reachng a potental nvestor. Second, the socal multpler ncreases wth the extent of socal nteractons as parameterzed by δ. Thrd, an ncrease n the ntensty of socal nteractons has a stronger mpact on the socal multpler the lower s the value of s, the frequency of sgnals. Usng equaton (6) to solve problem (2) gves the optmal number of sgnals wth socal learnng: 14

15 S N = (1 δ ) βbp( A I) a c β (1 δ ) (7) Equaton (7) mples that the wth socal learnng t s less lkely that an ntermedary wll βc(1 δ ) β c send no sgnals; ths wll occur only f P( A I) a whch s smaller than, the b b threshold for no sgnals f there s no socal learnng. In our settng, the exstence of socal learnng s equvalent to a more effcent nformaton technology and ths makes t more rewardng to send a postve number of sgnals. However, assumng a postve number of sgnals s optmally sent, equaton (7) mples that an ncrease n the ntensty of socal learnng has an ambguous effect on the optmal number of sgnals. It s easy to check that an ncrease n the ntensty of socal βc(1 δ ) learnng (a hgher value of δ) lowers the number of sgnals f P( A I) a > 4. b Thus, for some parameters values, fnancal assets dstrbutors choose to rely on socal nteractons to spread fnancal nformaton, thereby savng the cost of sendng sgnals. Ths s an mportant pont because t mples that socal nteractons can undermne agents ncentves to nvest n nformaton gatherng/spreadng as they may choose to wat and receve nformaton for free n the socal context. Substtutng equaton (7) nto equaton (6) the probablty of beng aware wth socal learnng s: 1 p( I) = 0 βc(1 δ ) bp( A I) a f f P( A I) a βc(1 δ ) / b P( A I) a > βc(1 δ ) / b (8) and mples that the probablty of beng aware ncrease wth the ntensty of socal learnng. These are addtonal propostons that can be tested emprcally. 7 7 Needless to say, the quanttatve effect of socal learnng on the sgnal polcy and the degree of awareness wll depend on the structure of the network. The structure assumed n our example s one where learnng s drectonal (ndvdual j learns from ndvdual j+1 but not vce versa) and sequental (j can learn from ndvdual j+1 but not from j+k, wth k>1). Ths structure s clearly arbtrary as any other one, and a pror t s not obvous what a realstc network structure looks lke. For nstance, f the structure s sequental but not drectonal, so that learnng can occur n both drectons, the probablty of beng aware depends on the sgnal accordng to the 15

16 3. Measurng fnancal awareness We explore the determnants of fnancal awareness usng the 1995 and 1998 Surveys of Household Income and Wealth (SHIW), conducted by the Bank of Italy. 8 The surveys collected nformaton on wealth, both real and fnancal, as well as ncome and demographc characterstcs. Before askng f households nvest n any partcular asset, and how much, ntervewers elct data on fnancal awareness. In partcular, each household head reports whether he or she s aware of the exstence of fnancal assets by answerng, for each asset category, the followng queston: I wll show you a lst of possble forms of savng. I would lke you to tell me whch forms of savng you (or another member of your household) know, even f only by hearsay. The fnancal asset categores refer to types of assets avalable to potental nvestors. Some of the categores correspond to a sngle asset (for nstance, checkng accounts and specfc types of government bonds, qute popular n Italy), but others refer to broad groups of assets (for nstance, stocks, mutual funds, and corporate bonds). Unfortunately, the survey does not dstngush between mutual funds and nvestment accounts that are predomnantly bonds or stocks. Two ponts about the wordng of the questons are worth stressng. Frst, those who are not aware of stocks or mutual funds should not be aware of any stock. But even those who report that they do know about stocks are lkely to know about only a small set. Therefore 2(1 s) δ δ (1 δ )(1 s) relaton: p( I) =. For gven values of s and δ, ths probablty s larger than f 2 2(1 s) δ learnng s drectonal, as n equaton (6). However, the qualtatve results of the model are the same: the effect of the ntensty of nteractons on the number of sgnals s ambguous, but the probablty of beng aware s larger wth socal nteractons than wthout. 8 The SHIW collects detaled data on demographc varables, households consumpton, ncome and balance sheets. The survey covers 8,135 households n 1995 and 7,147 n In each year, the surveys are representatve samples of the Italan resdent populaton. Samplng s n two stages, frst muncpaltes and then households. Muncpaltes are dvded nto 51 strata defned by 17 regons and 3 classes of populaton sze (more than 40,000, 20,000 to 40,000, less than 20,000). Households are randomly selected from regstry offce records. Households are defned as groups of ndvduals related by blood, marrage or adopton and sharng the same dwellng. The net response rate (rato of responses to contacted households net of nelgble unts) was 57 percent n 1995 and 44 percent n The SHIW archve can be downloaded from the web ste or obtaned by wrtng to: Bank of Italy, Research Department, Va Nazonale 91,

17 ther portfolo should be more dversfed than that of totally unnformed ndvduals, but they mght stll nvest n only a few stocks, contrary to the mplcaton of the classcal portfolo theory that n equlbrum all stocks should be held. Second, the queston dstngushes between aware and unaware ndvduals, but not between ndvduals who, apart from ts exstence, know very lttle about the asset - such as past returns, volatlty and lqudty - and more sophstcated nvestors. Fner data would of course shed further lght on the determnants of fnancal nformaton and on the effects of fnancal nformaton on household portfolos. 9 After answerng questons on fnancal awareness, the same ndvduals are asked two sets of questons to dentfy assets selected n the past and assets held at the end of the year: Have you or any other member of your household ever nvested n [ths partcular asset] at any tme n your lfe? Dd you or any of your household members have [ths partcular asset] at the end of the prevous year? Table 1 reports data on awareness of 14 types of fnancal asset, nvestment over the lfetme, and holdngs at the end of the year. The answers must be mutually consstent. If an asset s owned or was prevously owned, the respondent should report that the asset s known. If an asset s currently owned, the respondent should report that he has prevously purchased the asset. These consstency requrements apply to each ndvdual n the sample and to each asset. Inconsstency s very rare, causng less than 1 percent of the sample to be dscarded. Many households are aware of the exstence of certan assets even when they do not nvest n them. Not surprsngly, the most popular assets are transacton accounts (checkng, savngs and postal accounts), short-term government bonds (BOT and CCT), and bonds ssued by the natonal postal servce. About 5 percent of the sample do not know of the exstence of checkng accounts and 25 percent have never had one. Part of the reason s that some people, especally the elderly and the poor, use post-offce accounts, a close substtute. The most nterestng statstcs refer to rsker assets. Over one thrd of the sample are Roma, Italy. 9 The wordng of the queston ndcates that the respondent should report beng aware of the asset also f another household member s aware. Ths s unlkely to be a problem. Informaton flows wthn the household and f a member s aware of an asset, the nformaton s passed to the other members as well. Where fnancal decsons are a collectve choce, awareness by one of the members s shared wth the other members. And where fnancal nvestment s not a collectve choce, the head, as defned by the SHIW, s the person n charge of the fnancal 17

18 not aware of stocks, 50 percent do not know about mutual funds and corporate bonds, and almost 70 percent are unaware of nvestment accounts. Combnng, less than 30 percent of the sample s smultaneously aware of stocks, mutual funds and nvestment accounts. Except for stocks, awareness ncreases by 6 or 7 percentage ponts between 1995 and 1998 for mutual funds, nvestment accounts and corporate bonds. The other columns n Table 1 document the Italan stockholdng puzzle and the lack of dversfcaton of most household portfolos. In 1995 only 5 percent were drect stockholders, and 7.8 percent n In 1998 total stock market partcpaton through stocks, mutual funds or nvestment accounts was just 15 percent. The standard explanaton of ths asset allocaton puzzle ctes entry costs. As we shall see n Secton 5, asset awareness s a complementary explanaton. The data can be used to construct summary ndcators of fnancal awareness. One measure s smply the number of assets that each ndvdual knows about dvded by the number of potental assets (14 n all). A second measure s an ndex that gves less weght to popular assets (such as checkng accounts) than to assets that are less wdely known (such as corporate bonds and mutual funds). In practce, we weght the ndex by the nverse of the proporton of people aware of the asset, and scale t by the sum of the weghts. 11 The two ndcators are obvously very strongly correlated and provde useful summary statstcs of fnancal awareness. They can also be convenently related to household characterstcs n the descrptve and regresson analyss of Secton 4. Sample statstcs on the two ndexes of fnancal awareness are reported n Table 2. On average, n 1998 respondents were aware of 59 percent of the assets (50 percent usng the weghted ndex). The crosssectonal dstrbuton of the ndex reveals consderable heterogenety of potental nvestors. Households n the frst quartle of the dstrbuton are aware of only one thrd of the assets (4 out of 14). Those n the fourth quartle are aware of at least 12 assets; 15 percent of the sample reports beng aware of all asset categores. decsons of the household. 10 Ths s an overestmate of ndrect stockholdng because some households have mutual funds that nvest predomnantly or exclusvely n bonds or n the money market. Snce the survey does not dstngush between dfferent categores of mutual funds and nvestment accounts, we assume that f a household has a mutual fund or an nvestment account he nvests at least part of hs wealth n stocks. 11 For nstance, checkng accounts have a weght of 1.046, stocks

19 4. The determnants of fnancal awareness The model outlned n Secton 2 has three relevant testable mplcatons. Frst, ssuers wll target the ndvduals (or groups) that have a greater probablty of nvestng n the stock market. Clearly, the benefts of a euro spent on nformaton are greater where, once ndvduals are aware of nvestment opportuntes, the chances of adopton are hgh. Second, ndvduals are more lkely to be aware where the cost of sendng sgnals s lower, e.g. n areas where the cost of contactng nvestors s relatvely low. Thrd, awareness should be hgher n areas where the chance of learnng from others s hgher, because n those areas one can learn from peers as well as from the general meda and from ntermedares. In the model we have mplctly assumed that ssuers send sgnals evenly to all potental nvestors, and have related the ncentve to send sgnals to the average probablty of buyng among the aware, multpled by the average amount nvested by those who do buy the stock, or p(a I) a. Ths s a reasonable assumpton f nformaton s communcated through, say, TV or other general meda, so that n prncple all potental nvestors are contacted. However, advertsement s costly, and t s unwse to send sgnals to people who are unlkely to buy stocks even f nformed about them. A more realstc case s one n whch ssuers or dstrbutors observe some characterstcs of potental nvestors that are correlated wth the probablty of buyng stocks and the amount nvested. Then, ssuers are able to group potental nvestors accordng to these characterstcs and target the lkely buyers. The mmedate mplcaton s that the probablty of recevng a sgnal also depends on a set of observable ndvdual characterstcs assocated wth stockholdng. In the emprcal analyss we focus on household resources (ncome, fnancal wealth, real wealth), age and educaton as proxes for the probablty of adopton and the average amount nvested, p(a I) a. Snce wth fxed costs of adopton the affluent are more lkely to buy stocks and nvest larger amounts, they wll receve more sgnals and wll therefore be more lkely to be aware. A smlar argument apples to ndvduals wth unversty educaton and to younger people, n-so-far as they follow the practce of fnancal advsors of nvestng more n stocks when young. 12 On the other hand, groups wth very low probablty of buyng 12 Bode, Merton and Samuelson (1992) show that ths popular advce s supported by theoretcal arguments. 19

20 stocks are not targeted and reman unaware, unless there are nformaton spllovers from other ndvduals. In order to test the relaton between awareness and the cost of sendng sgnals we rely on geographcal dfferences n newspapers readershp. We focus on sales of natonal newspapers (defned as newspapers sold n at least half of the Italan provnces) as they host the greatest porton of fnancal product advertsement. Most mportantly for our purposes, the cost of advertsng fnancal products n natonal newspapers s borne out at the natonal level and reflects the overall readershp, rather than local readershp. Therefore, the effectve cost of contactng nvestors and spreadng nformaton s lower n areas where newspapers sales are hghest. For example, suppose that the cost of sendng a sgnal usng a natonal newspaper s x, that there are two regons and that readershp s twce as large n the frst regon. Then the effectve cost of contactng an unaware nvestor wll be twce as large n the second regon. Thus, one drvng varable of awareness should be newspaper readershp, as measured by the number of copes sold n the local market scaled by the local populaton. Ths rato, computed by poolng together the 14 newspapers that sell n at least half of the Italan provnces, vares consderably across provnces, rangng from less than 1 newspaper per 100 nhabtants n the Sclan provnces of Agrgento, Caltanssetta and Enna to over 15 newspapers n the Northern provnces of Genoa, Pacenza and Ravenna. 13 The cost of contactng nvestors through the general press s accordngly lower n, say, Genoa than Agrgento. As a proxy for socal nteractons our thrd determnant of awareness we use the number of voluntary organzatons excludng sport clubs and organzatons that represent group nterests - per 1,000 nhabtants n each provnce. 14 As shown n Fgure 1, the ndcator vares consderably across provnces, from a mnmum of 0.07 n the Southern provnce of Fogga to a maxmum of 0.18 n Genoa. The chart also shows that socal nteractons are more ntense n the Northern provnces, suggestng that our regressons must control for North- South dfferences to avod smply pckng up a North-South dvde. Although t s not obvous a pror how to measure the ntensty of socal nteractons n 13 The lst ncludes: Avvenre, Correre della Sera, Gornale, Il Gorno, Itala Ogg, Manfesto, Il Mattno, Il Messaggero, Repubblca, Il Resto del Carlno, Il Secolo XIX, Il Sole 24 Ore, La Stampa, Il Tempo. We exclude sport newspapers as they are not used as a vehcle for fnancal nformaton. Restrctng the lst to the 5 largest natonal newspapers (Correre della Sera, Repubblca, La Stampa, and the two busness papers Sole 24 Ore and Itala Ogg) does not change the econometrc results. 20

21 a communty, alternatve avalable measures tend to be hghly correlated. In fact, as shown by Putnam (1993) wth reference to Italan regons, communtes that are more socal n one dmenson (e.g. partcpaton n voluntary organzatons concerned wth health, such as blood donaton) tend also to be more socal n other dmensons (e.g. partcpaton n poltcal movements, recreatonal and charty groups, engagement n the cvc communty, etc.) Descrptve evdence We start wth a graphcal analyss of the correlaton between fnancal awareness and educaton, age, wealth, densty of fnancal salesmen and socal learnng. In each case, we graph awareness of stocks, mutual funds, nvestment accounts, corporate bonds and the overall ndex of fnancal nformaton separately. We choose to focus on the weghted ndex for all fnancal assets and for the four rsky assets combned. Results for the unweghted ndex, not reported for brevty, are smlar. In each graph we merge 1995 and 1998 data. In the regresson analyss, however, we ntroduce a tme dummy to dstngush between the two surveys. The relaton between educaton and nformaton (Fgure 2) s postve and qute strong. The proporton of ndvduals aware of stocks ncreases from 25 percent for those wth no more than elementary educaton to 80 percent for those wth a unversty degree. Over the same range of educaton, the proporton aware of mutual funds rases from 5 to 60 percent, and the overall ndex of fnancal awareness from 20 to 75 percent. In Fgure 3 we plot the proporton of households aware of stocks, mutual funds, nvestment accounts, corporate bonds and the ndex of fnancal awareness by year of brth. Awareness clearly ncreases wth year-of-brth, partcularly for cohorts born between 1910 and Subsequent cohorts (born ) dsplay only a moderate ncrease n awareness, for each of the assets consdered. Wth only two years of data, we cannot dentfy the separate effects of cohort and age. If we were to nterpret the data n terms of age, absent any cohort effect, we would conclude that fnancal nformaton falls wth age, wth the mplausble mplcaton that people start to decumulate past knowledge around retrement age. In our nterpretaton, rather, year-of-brth s one of the observable varables used by ntermedares to target potental nvestors. Snce 14 The source s 1 Censmento delle sttuzon prvate e mprese nonproft - anno 2000, Istat (2002). 21

22 younger cohorts tend to nvest more n rsky assets and are more lkely to partcpate, they wll also receve more sgnals and thus be more lkely to be aware. 15 The relaton between wealth and fnancal awareness n Fgure 4 s postve, consstent wth the hypothess that fnancal ntermedares target the affluent. Furthermore, the relaton s non-lnear. At low levels of wealth (less than 2,500 euros), the relaton s strongly postve. At hgher levels, the correlaton s stll postve but attenuated. Ths suggests consderng nonlnear terms n wealth n the regresson analyss below. Fgure 5 plots the proporton of aware ndvduals and the ndex of fnancal awareness aganst the cost of sendng sgnals, as proxed by the number of natonal newspapers sold per 100 nhabtants n a provnce. Awareness s postvely correlated wth readershp, partcularly at low levels of readershp. Fgure 6 dsplays a postve relaton between awareness and the ndex of socal learnng, n agreement wth the model of Secton 2. Overall, the descrptve evdence s consstent wth the predctons of the model whch relates the mechansm through whch consumers become aware of avalable assets to the economc ncentves of ssuers and dstrbutors Econometrc analyss Educaton, fnancal resources, and brth cohort are correlated varables: notorously educaton and ncome or wealth are postvely correlated, whle wealth and ncome vary n predctable ways wth age, as lfe cycle models mply. Educaton and wealth are also lkely to be correlated wth socal learnng, because the wealthy and ndvduals wth hgher educaton are more lkely to nteract and learn from others. To account for these correlatons and to solate the contrbuton of each factor whle holdng others constant, we run probt regressons for the probablty of ndvduals beng aware of stocks, mutual funds, nvestment accounts and corporate bonds, and Tobt regressons for the ndex of fnancal nformaton. Table 3 reports summary statstcs mean, standard devaton, mnmum and maxmum value for all the varables used n the estmaton. Data are pooled over 1995 and Household head s defned as the person prmarly responsble for economc decsons. They 15 If we nterpreted the profle n Fgure 2 n terms of age rather than cohort, a flat or even declnng agenformaton profle would also contrast wth the hypothess set forth by Kng and Leape (1987), who explan the ncreasng pattern of asset dversfcaton over the lfe-cycle n terms of a postve relaton between age and 22

23 are males n about 70 percent of the cases; on average, fnancal wealth s 18,000 euros, and real wealth about 120,000 euros; over 20 percent of the sample have a hgh school dploma, 7 percent a unversty degree and 1 percent an economc degree. Comparson between the two surveys ndcates that the sample s qute stable n demographc structure, educaton of the head and regonal locaton. Besdes controllng smultaneously for economc resources (fnancal wealth, real wealth, household dsposable ncome), educaton, year-of-brth, socal learnng and densty of fnancal ntermedares, we nclude n each regresson a dummy varable for whether the household head s marred or male and a tme dummy to control for dfferences between survey years. We also nclude the Herfndhal ndex n each provnce and year, as a proxy for the compettve structure of local fnancal markets. The lterature on advertsement suggests that the compettve structure of the market affects producers ncentves to dssemnate nformaton on ther products (Trole, 1989). If the gans from spreadng nformaton can be approprated by the compettors as n ndustres wth relatvely hgh product substtuton and low market power ssuers would have less ncentve to dssemnate basc nformaton. However, the coeffcent of ths varable never turns out to be statstcally dfferent from zero. As another ndcator of banks behavor affectng stock and other fnancal assets awareness, we defne a dummy varable takng the value of one f the respondent has a longterm relaton (more than 10 years, or more than 5 years) wth a bank. Our hypothess s that, controllng for age, educaton and economc resources, banks are more lkely to target ndvduals on whch they have accumulated more nformaton (for nstance, because they have a more precse assessment of fnancal wealth and portfolo behavor). These ndvduals are therefore more lkely to have receved sgnals n the past, and, therefore, more nformed. Snce we use provncal varablty to measure dfferences n the cost of dstrbutng nformaton, n the ntensty of socal learnng and to proxy competton n the local markets, the standard errors of our estmates are adjusted for clusterng. Furthermore, to make sure that our geographcal ndcators do not pck up dfferences between the North and the South that just happen to be correlated wth measures of socal nteractons and the cost of dstrbutng nformaton, we add to the regresson a dummy varable for the North. To make sure that socal nteractons and newspaper readershp are not pckng up geographcal dfferences n fnancal sophstcaton. 23

24 economc development, we have also expanded the set of regressors to nclude provncal per capta GDP and the provncal unemployment rate. Snce these varables were never statstcally dfferent from zero, they are dropped n the reported specfcaton. The probt results n Table 4 confrm the patterns n Fgures 2 to 6. The coeffcents of the cohort dummes are postve for each of the assets consdered, ndcatng that the older cohorts are less lkely to be aware than the young. Educaton s a strong predctor of fnancal awareness. In partcular, havng a unversty degree s assocated wth an ncrease of 17 percentage ponts n the probablty of beng aware of stocks, and of 25 ponts for mutual funds, nvestment accounts and corporate bonds. Havng an economc degree further ncreases the probablty of awareness of mutual funds, nvestment accounts and corporate bonds by 13 to 21 ponts. Only n the case of stocks s the coeffcent of the dummy for an economc degree not statstcally dfferent from zero. The coeffcents on fnancal wealth, real wealth and ncome ndcate that the awareness s postve correlated to ndvdual resources. Increasng smultaneously the three varables from the 25 th to the 75 th percentle of ther dstrbuton, rases the probablty of beng aware of stocks by 13 percentage ponts, and that for mutual funds, nvestment accounts and corporate bonds by 18, 11 and 19 ponts, respectvely. Expermentng wth quadratc terms of these varables does not change these conclusons. Our nterpretaton s that these correlatons reflect the ncentves of ntermedares to target fnancal nformaton prmarly towards ndvduals wth a hgher probablty of actually buyng the fnancal nstruments they advertse. 16 The dummy for long-term bank relaton (more than 10 years) has a strong mpact on awareness, between 5 and 8 percentage ponts, dependng on the asset consdered. Snce we are holdng constant age, educaton and economc resources, the most plausble nterpretaton of ths effect s that t s supply-drven : banks have a greater ncentve to nform ndvduals on whch they have superor nformaton. Results are unchanged f long-term relatons are defned over 5-years. Newspaper readershp has a postve mpact on awareness, and ts coeffcent s hghly 16 Another possblty s that educaton and wealth proxy for ndvdual characterstcs that are related to ndvdual exposure to fnancal nformaton. For nstance, the better educated and the affluent may have access to crcles where fnancal nformaton s more easly avalable, and therefore have more frequent contacts wth fnancal ntermedares. Gven the reduced form of our regressons, we cannot dstngush ths partcular channel from the explct targetng of some populaton groups by fnancal ntermedares suggested by our 24

25 sgnfcant n all the regressons. Increasng readershp from the lowest (the Sclan provnce of Agrgento) to the hghest value (the Northern provnce of Ravenna) rases the probablty of stock awareness by 5.4 percentage ponts and that of beng aware of mutual funds, nvestment accounts and corporate bonds by 25, 23, and 21 ponts, respectvely. Smlar results are obtaned f we use the provncal readershp of the top fve natonal newspapers or of the leadng natonal economc newspapers (Il Sole 24 Ore and Itala Ogg). The coeffcent of the proxy for socal learnng s postve n all regressons, and statstcally dfferent from zero at conventonal levels for stocks, nvestment accounts and corporate bonds. Rasng the ndex of socal learnng from the lowest to the hghest value (Fogga and Genoa, respectvely) ncreases the probablty of beng aware of stocks by 12 percentage ponts; for mutual funds, nvestment accounts and corporate bonds the respectve fgures are 14, 12 and 8 percentage ponts. 17 To make sure that our results are not drven by the partcular measure chosen we check ther robustness wth an alternatve measure: the number of non proft organzatons, scaled by populaton n the provnce (Mortara, 1985). A non-proft nsttuton s any organzaton whose status does not allow ts members, founders or those n control, to obtan any ncome or other yeld through t. The estmates show that also ths proxy of socal nteractons has a postve and statstcally sgnfcant effect on fnancal awareness. Table 5 presents a Tobt regresson for the weghted ndex of fnancal awareness usng the same specfcaton as n Table 4. A two-lmt Tobt estmator s warranted because the ndex ranges from 0 for 248 ndvduals reportng beng aware of no asset at all, to 1 for 2,585 ndvduals aware of all 14 assets. Also n ths case standard errors are adjusted for provncal cluster effects. We report results for the ndex based on all fnancal assets and for that referrng to rsky assets only. In both cases the results confrm the evdence on ndvdual assets. Awareness s strongly correlated wth educaton, year-of-brth, wealth, long-term banks relatons, newspaper readershp and the ndex of socal learnng. Rasng economc resources (fnancal wealth, real wealth, and dsposable ncome) from the 25 th to the 75 th percentle ncreases the overall ndex of fnancal awareness by 9 model. 17 Secton 2 shows that more ntense socal nteractons have an ambguous effect on the optmal number of sgnals sent by fnancal ntermedares. Snce we don t observe the sgnals, we cannot estmate the relaton between ntensty of nformaton producton and strength of socal nteractons. 25

26 percentage ponts (15 percent f we consder the ndex relatve to rsky assets only). Longterm relatons ncrease the ndex by 6.5 percentage ponts. Increasng the densty of newspaper readershp and the ndex of socal learnng from the lowest to the hghest value ncreases the overall ndex by 8 and 11 percentage ponts, respectvely. Lke Table 4, ths s evdence of the awareness mechansm outlned n Secton Implcatons Fnancal awareness carres major mplcatons for at least two mportant ssues n the analyss of household portfolos: the extent to whch lack of awareness explans the stockholdng puzzle, and whether falng to consder asset awareness leads to overstatng partcpaton costs. Consder a stuaton n whch nvestors can choose between a safe and a rsky asset (bonds and stocks). Stocks yeld an equty premum equal to ~ r, dstrbuted accordng to the p.d.f. g (r ~ ), wth expected value ~ > 2 E r = r 0 and varance σ. We normalze the return on bonds to one and assume that n some states of the world r ~ <0 so that stocks do not domnate bonds. Each nvestor s endowed wth wealth w and nvests a fracton of wealth α n stocks. The nvestor must pay a fxed entry cost f (say, a brokerage fee) to enter the stock market. If he chooses to purchase stocks, he pays f and nvests α w n stocks; otherwse he keeps all of hs wealth n bonds. There are two types of nvestors, aware and unaware. Aware nvestors know of the exstence and characterstcs of both assets and have the same nformaton on the probablty dstrbuton of the stock return g (r ~ ). The others are unaware that stocks exst. Hence, they can only nvest n bonds, regardless of entry costs. The shadow cost of gnorance of stocks s r, the expected excess return. 18 Let I x ) be an ndcator functon equal to 1 f the nvestor s aware and zero f ( 18 One could consder a thrd type of nvestor, aware of stocks but not well nformed about the dstrbuton of the return on them. For nstance, he mght perceve a p.d.f. g ~ u (r ) wth the same mean as g(r ~ ) but larger varance. Other thngs equal, ths nvestor s less lkely than fully nformed nvestors to enter the stock market. 26

27 unaware. As was shown n Sectons 2 and 4, the ndcator depends on a vector of characterstcs x whch nclude the costs of dssemnatng fnancal nformaton n the local market, the strength of socal nteractons, and personal characterstcs, such as educaton, cohort, and wealth. If I ( ) = 0 all wealth s nvested n bonds and α = 0. If I ( ) = 1, the problem of the aware nvestor s: x max and the optmal share nvested n stocks, α Eu [( α ~ r + 1)( w f )] * α, satsfes the frst order condton: * [( ~ r 1) ~ r ( w f )] 0 Eu' α The nvestor chooses to nvest n stocks f: + * [( ~ r + 1)( w f )] u( w ) Eu α > (9) If the beneft from stockholdng exceeds the fxed cost, the nvestor chooses to purchase stocks, pays the fxed cost f and nvests * α (w -f ) n stocks. Gven our assumptons, x * α s strctly postve. Condton (9) ndcates that, for gven w and f, partcpaton s more lkely f the excess return s hgh. Snce one addtonal euro of wealth ncreases the rght-hand sde more than the left-hand-sde, there exsts a suffcently hgh level of wealth that trggers stock market partcpaton. As entry costs approach zero, all aware nvestors purchase stocks. Equaton (9) delvers three nsghts. Frst, f all nvestors are aware of stocks, everyone above the wealth threshold nvests n stocks. Second, f there are no entry costs, the people who do not nvest n stocks are smply those who are not aware of ther exstence. Thrd, wth both unaware nvestors and entry costs, a person who does not nvest n stocks may be unnformed or may have low wealth. Let now rˆ be the certanty equvalent equty premum defned mplctly by 19 Eu * [ ~ * ( α r + 1)( w f )] = u[ ( α rˆ + 1)( w f )] 19 The certanty equvalent premum s approxmately equal to degree of relatve rsk averson evaluated at fnal wealth. * 2 1 α σ r ˆ = r 1 a *, where a s the nvestor's 2 1+ α r 27