Social Interaction and Stock‐Market Participation

Abstract

We propose that stock-market participation is inf luenced by social interaction. In our model, any given "social" investor finds the market more attractive when more of his peers participate. We test this theory using data from the Health and Retirement Study, and find that social households-those who interact with their neighbors, or attend church-are substantially more likely to invest in the market than non-social households, controlling for wealth, race, education, and risk tolerance. Moreover, consistent with a peer-effects story, the impact of sociability is stronger in states where stock-market participation rates are higher.The Journal of Finance in the stock market. On the one hand, if one takes the perspective of a fullinformation, frictionless model with optimizing households-in which those who sit out do so simply because they find the market's risk-return profile unattractive-standard arguments suggest that there is nothing to be gained by having the government invest in the market on their behalf. On the other hand, if households do not participate because of a lack of information about market opportunities, or because other frictional costs deter them from doing so, the case for these proposals can, at a minimum, begin to make logical sense. 2 A few basic facts about the determinants of household participation in the stock market are already well known. 3 First, participation is strongly increasing in wealth. This can be understood by thinking of participation as involving fixed costs; wealthier households have more to invest, and so the fixed cost is less of a deterrent to them. Vissing-Jorgensen (2000) builds a model in which fixed costs of participation are incurred on a per-period basis, and estimates that such costs have to be on the order of $200 per year to explain observed participation rates. Of course, such large numbers beg the questions of what these black-box fixed costs actually represent, and whether one should think of them as being similar across different types of households.Stock-market participation has also been found to be increasing in household education. One interpretation is that education reduces the fixed costs of participating, by making it easier for would-be investors to understand the market's risk-reward trade-offs, to deal with the mechanics of setting up an account, and executing trades, etc. 4 Finally, there is also a pronounced link between race and participation, with white, non-Hispanic households having much higher participation rates, controlling for wealth and education.In this paper, we add to this line of work by considering the possibility that stock-market participation is inf luenced by social interaction. A priori, this would seem to be a promising hypothesis, given the growing body of empirical research that speaks to the importance of peer-group effects in a variety of other contexts. 5 Notably, some of this work finds evidence of peer effects in financial settings that are suggestively close to the one we have in mindfor example, Madrian and Shea...

Susceptibility to and impact of interpersonal influence in an investment context

“…On the one hand, consumers often deliberately increase the visibility of their investment decisions and expose themselves to public scrutiny by engaging in related social interactions, such as joining investment clubs , or discussing their investment decisions and performance with other stock market participants (Hong et al 2004). On the other hand, consumer research argues that both the real and the imagined presence of others significantly influence people's behavior (Kropp et al 1999: 537).…”

Social Capital and Stock Market Participation via Technologies: The Role of Households’ Risk Attitude and Cognitive Ability

“…This conjecture is supported by several proposed explanations in the literature contemplating the role of participation costs in solving this puzzle [17,[20][21][22][23][24][25][26]. Moreover, scholars also reflected on behavioral approaches such as risk attitude [15,[27][28][29][30][31][32][33]; cognitive ability of households such as financial awareness [34], financial literacy [35], and IQ [36]; and sociological aspects including social interaction [5,8,12], trust [7,11] and shared vision [6,9,10,13]. This study reflects on the articles, considering risk attitude, cognitive ability, and sociological factors to explain the puzzle in stock market participation from the recommended journals in finance such as the Journal of Finance, Journal of Financial Economics, Review of Financial Studies, and Review of Finance.…”

“…Hong et al [5] wrote a seminal paper and explained stock market participation using structural social capital and studied social interaction. The role of sociability was studied by Georgarakos and Pasini [8], while Campbell et al [12] reflected on the influence of social engagement on stock market participation.…”

“…A seminal study on structural social capital considering social interaction was conducted and it was revealed that social households, or those who interact with their neighbors or attend church, are substantially more likely to invest in the market than non-social households and concluded that the impact of sociability is stronger in states where stockmarket participation rates are higher [5]. In addition, Georgarakos and Pasini [8] discussed that sociability can equalize the impact of despondency on stock market participation instigated by low existing trust within places.…”

“…In effect, there is progress in exploring and explaining the rationality behind investor decision making through behavioral finance [4]. The previous studies on investment decision, particularly in stock market participation, have focused on solving the participation puzzle by linking social factors [5][6][7][8][9][10][11][12][13].…”