Equity Culture and Household Behavior

Equity culture has spread among households on both sides of the Atlantic. We analyze the likely changes in behavior of households that enter the stock market in response to arrival of information about how to invest in stocks. 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 and borrowing, and to reduce net financial wealth. At the same time, they tend to accumulate more precautionary wealth. By creating greater incentives to borrow, equity culture makes the young more susceptible to any borrowing constraints. Whether borrowing-constrained entrants increase consumption at all depends on risk aversion and on the tightness of the borrowing limits they face. Borrowing constraints can also reduce, eliminate, or reverse the tendency of entrants to hold larger precautionary wealth buffers