from the St Louis Fed

— this post authored by YiLi Chien and Paul Morris

From 1928 to 2016, the average annual stock return was about 8 percentage points higher than the return on three-month Treasury bills. This leads to sizable return gaps over time: $100 investments in stocks and in Treasury bills in 1928 would have yielded nearly $329,000 and $2,000, respectively, 88 years later.[ 1]

Given the high return of stocks, it is puzzling that many households do not participate in the stock market and, hence, forgot the high return. In addition, the nonparticipation behavior is at odds with modern portfolio theory. The theory implies that all households should invest at least a fraction of their wealth in stocks in order to take advantage of the equity premium. However, the data show that many households do not participate in financial markets.

The inability of modern portfolio theory to explain what is observed in the data leads to a “participation puzzle.” A common explanation of this puzzle is the individual participation cost, which includes both monetary and nonmonetary costs. The monetary costs are relatively straightforward, including transaction or brokerage fees. The nonmonetary costs are broadly defined to be the cognitive and time costs of understanding the investment object or processing previous experiences with stock markets. The participation cost, especially the nonmonetary costs, could vary widely across the population.

While this participation puzzle has been well-documented at the national level, this article takes a first step in exploring whether the rates vary geographically. The aim is to see if the participation rate at the national level occurred homogeneously across states or if people in some states participated at a higher rate than others.

If the data indicate that there are regional differences in these rates, academic researchers could explore these disparities to better understand and resolve the puzzle. In addition, a better understanding of households’ investment decisions across regions could improve the quality and effectiveness of conducting government policy.