Consumption Response to Frequent Stock Market Wealth Shocks

Using a proprietary dataset linking stock investment and financial activities at the individual level, we study the causal impact of high-frequency stock market wealth fluctuations on household consumption decisions. Given the large stake of household stock market participation, the household sector serves as an important transmission channel of the stock market fluctuations to the real economy. Following the spirit of Di Maggio, Kermani, and Majlesi (2020), we plan to investigate the response of consumption to the same individual’s stock market returns in the previous six months among the investors in our sample. At a low frequency (eg., annual level), stock investment returns may be treated as real wealth shocks, leading to a large and significant marginal propensity to consume (MPC) out of both the realized and unrealized capital gains. However, the same logic cannot be directly applied to a higher frequency (eg., monthly level). Given the fact that the stock investment returns are volatile and fast-changing, understanding households’ responses at a higher frequency hence bear the same importance as studying the relationship under a lower frequency.
The preliminary bin-scatter plots suggest that there is a potential negative relation between last-month stock returns and current-month consumption, a positive relation between stock returns two and three months ago and current-month consumption, and an insignificant relation between stock returns in earlier stock returns and current consumption. After identifying the main result, we will disentangle the possible mechanisms. For example, if we observe a small or even non-significant average effect, it is possible that households either simply do not treat the transient stock market investment returns as real shocks to their financial wealth and hence tend not to adjust their consumption, or they do observe and regard them as real income shocks, but they do not have to adjust their consumption to such nonpermanent income shocks given little liquidity constraint. We can potentially distinguish the two mechanisms by investigating the heterogeneous effect by liquidity constraint status: a similar small response across highly-constrained and non-constrained households will be more consistent with the first interpretation, while a larger MPC for highly-constrained
households will be more consistent with the second interpretation. Academically, we contribute to the literature on the effect of wealth shocks on household consumption and the real impact of stock market fluctuations. Practically, our study can serve as a good reference to comprehensively understand the impact of stock market fluctuations for public policymakers.