Does social connectedness affect stock market participation?

Everybody should purchase stocks, a minimum of a really small percentage of the wealth. This suggestion is most likely among the couple of consensuses that business school professors and economists share. Without digging into sophisticated economic models, you could easily understand why by checking some stats. The typical annual return in america stock exchange previously 90 years is up to 7.8%, much greater compared to rate of interest on savings accounts and also the 3-month Treasury bill rate. Even if your are very risk-averse, she could still invest a comparatively small part of her wealth to savor our prime equity premium. To researchers’ surprise, there’s a considerable quantity of households who don’t have fun playing the stock exchange whatsoever. What’s much more striking is this fact nonparticipation exists across all earnings levels and it is broadly documented in a variety of countries. Nonparticipation in the stock exchange not just deteriorates households’ personal finances, but additionally can lead to greater earnings inequality minimizing economic output in today’s world. It’s in researchers’ own interest and with regard to public interest to review the motives why (why is this so) households purchase the stock exchange.

Inside a new paper, I read the word-of-mouth funnel to find out if your friend’s stock exchange participation decision affects your personal participation decision. You could do since not everybody understands the advantage of stock investments. You could discover the details if her friend shares the positive investment knowledge about her. Although I don’t have data around the stock holding information of citizens inside a country, we’re able to still study aggregated data and apply the mix-sectional variations available market participation rates across regions.

Figure 1: Direct stock exchange participation rates across US counties in 2018

Map of america showing Figure 1: Direct stock exchange participation rates across US counties in 2018

Figure 1 shows the direct stock exchange participation rates in US counties in 2018. I explore the government Statistics of Earnings data to acquire county-level aggregated taxes data and estimate direct stock exchange participation rates as the number of tax filers with dividend taxes within the final amount of tax filers.1 The wide mix-sectional improvement in participation rates across counties hints there exist unobservable determinants of households’ participation decision for researchers to research.

I combine the county-level participation rates using the Facebook Social Connectedness Index (SCI) data. The Facebook SCI shows how strongly any random county pairs within the U . s . States are connected. Facebook constructs the SCI data by utilizing Facebook user friendship links across regions. The greater the index is, the 2 counties are socially more connected. Then i build the primary explanatory variable within my paper, Friends’ Participation. For every county in every year, its Friends’ Participation is calculated as SCI-value-weighted participation rates within the same year all other counties within the U . s . States. To prevent any spillover effects because of geographic nearness, I exclude the participation rates in the same condition when constructing Friends’ Participation.2

I’ve found that Friends’ Participation positively and statistically considerably predicts the focal county’s stock exchange participation rates in the year after. After controlling for demographic effects, including population, earnings level, education, local economic conditions, local stock performance, in addition to lengthy-term trends and customary shocks shared inside the same condition, a 1 percentage point rise in Friends’ Participation results in a rise of approximately 25 basis points within the focal county’s participation rate within the next year. Economically, which means that, other activities equal, a 1 standard deviation rise in Friends’ Participation induces greater than 40 formerly nonparticipants to begin purchasing the stock exchange within an average county of fifty,000 population.

Everyone knows that correlation doesn’t suggest causality. The identified association between friend counties’ participation decision should reflect how similar friend counties are. Therefore, to supply a level clearer picture behind this word-of-mouth funnel, we want some exogenous shock that just affects certain counties’ participation decision after which examine if the local shock transmits with other connected counties.

The shock I utilize is financial fraud thought. FINRA requires financial advisory firms to report misconduct occasions by their workers each year. I estimate the amount of financial misconducts revealed each year in each and every county and discover that certain misconduct thought in 1,000 population lessens the market participation rate by about 30 basis points within the following 2 yrs. Economically, which means that upon one financial misconduct event being revealed among 1,000 people, three formerly stock exchange participants could be scared away and choose not to purchase the stock exchange any longer. This shock doesn’t have effect prior to the thought, and many of these reports that FINRA collects are extremely local and wouldn’t be broadcasted nationwide. Thus, the thought of monetary misconduct qualifies because the exogenous shock within my study. After instrumenting Friends’ Participation using financial misconduct revelations, the outcomes still hold, suggesting the relationship between Friends’ Participation (in the last year) and also the focal county’s stock exchange participation decision will probably be causal.

Figure 2: Local participation reaction to thought of monetary misconduc

Stock chart showing Figure 2: Local participation reaction to thought of monetary misconduct

Policy Implication

Study regarding why (why is this so) people participation in the stock exchange is of first-order importance in finance research. Within this paper, I combine two novel data sets and reveal that the stock exchange participation decision in socially-connected counties may affect the focal county’s stock exchange participation decision . This finding shows that the reduced participation rates, especially among low-earnings households, might be related to low financial literacy or lack of knowledge from the financial market. Your clients’ needs greater financial literacy, policy makers may achieve greater stock exchange participation rates of all earnings levels and finally improve earnings inequality.

1 Readers may find details why this estimation is a fairly proxy for stock exchange participation rates in section 2.2 “What will the IRS participation rate capture?” within my paper.

2 In section 3.3 “The effects from geographic and socially connected friends” within my paper, I reveal that the influence of geographically close counties exhibits even more powerful effects.

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