The Consumption Response to Stock Market Wealth

Topic and Objectives

Predicting households’ consumption sensitivity and marginal propensity to consume (MPC) is of interest to both researchers and policymakers when it comes to designing economic stimulus programs, taxation schemes, and social security systems. For more than sixty years researchers have empirically tested Friedman’s permanent income hypothesis (PIH) from the year 1957 - with mixed results. The emergence of digital personal finance management tools which record and automatically allocate households’ current account transactions into income and spending categories allows for very granular assessments of MPC and therefore for better tests of the PIH. A large European bank that introduced personal financial management tools to its clients two years ago provides us access to the records of over 100,000 clients and with transaction and balance data for all other savings and brokerage accounts of these clients. This allows us to measure if and how consumption patterns of clients change when they incur (unanticipated) capital gains and losses in their risky portfolio holdings. While previous literature has relied upon measurement-error-prone survey data or aggregate estimates of consumption trends and stock market gains, our research design allows investigating precisely how consumption evolves with changes in an individual's investment portfolio. Furthermore, because of the detailed nature of the data, we can test behavioral theories such as mental accounting and if individuals layer their portfolios by analyzing if consumption responses vary by the returns from different types of asset classes.

In closely related current work (working paper by Becker & Hackethal 2017), we have been using the same data set to analyze MPC in response to transitory income and found varying response patterns depending on income type and client characteristics. The partner bank confirmed that we can also use their survey tool to target information treatments combined with brief online questionnaires of selected clients from our sample. This will allow us to observe changes in individual market expectations or risk preferences in response to any significant market events during 2018 (while our project is running). These observations are helpful for explaining individual MPC found in the current account data.

Key Findings

• Private consumption is excessively sensitive to dividend income. Investors across wealth, income and age distributions increase spending precisely around days of dividend receipt.
• Our results are at odds with several existing rational and behavioral explanations such as financial constraints and impulsiveness. Instead, consumption responses reflect ‘planned’ excess sensitivity, driven by investors who select dividend portfolios, anticipate dividend income, and plan consumption accordingly.

Policy Implications

• Private households treat dividend income akin to rent income and plan consumption according to dividend payouts