The Forgone Gains of Incomplete Portfolios

This article proposes a test for the cost-based explanationof nonparticipation, by estimating a lower bound to the forgonegains of incomplete portfolios; these are in turn a lower boundto the costs that could rationalize nonparticipation in financialmarkets: high bounds would imply implausibly high costs. Assumingisoelastic utility and a relative risk aversion of three orless, for the stock market I estimate an average lower boundof between 0.7 and 3.3 percent of consumption. Since total annual(observable plus unobservable) participation costs are likelyto exceed these bounds, the cost-based explanation is not rejectedby this test.