Wealth inequality is a major global issue – the richest 10% of the world’s’ population hold some 75% of all wealth. One important factor is stock market participation. Over time and on average, stock market investors, long term holders of index tracker funds for example, end up wealthier than those who put their money on deposit. Yet, despite the proven benefits, many people are reluctant to invest in the stock market.
Why it’s important
Understanding what influences people’s attitudes to financial risk taking may help reduce wealth inequality. HEC professor Ziwei Zhao and co-researcher Min Cui use US household data from 1999 to 2015 to reveal one key factor – the interaction between parent and child as the child grows up, combined with the parents’ experience of the stock market just before the child is born. Here, ‘experience’ means being aware of how the stock market is performing.
What our professor has to say:
“Imagine two sets of parents,” says Prof. Zhao. “Before having children, parents A experience a market crash and recession, but parents B experience a long bull market. All else being equal, child A’s view of the stock market and attitude to risk will be dampened by his parents’ bad experience. He’s less likely to invest in the stock market.”
It’s an effect that persists after children have left home, spans generations, and can lead to significant wealth inequality. If each family in the data sample gets a notional $1000 to invest then, after two decades and two generations of investment decisions shaped by the grandparents’ different experiences of the market, the amounts the grandchildren end up with range from $508 to $19,537.
The impact on wealth inequality can be measured using the Gini coefficient where zero is perfect equality and one is perfect inequality. As Prof. Zhao notes: “In our example everyone has $1000 at the start, so the coefficient is zero. After three generations, with the only changing factor being how the grandparents’ experience affects the investing decisions of subsequent generations, the coefficient is 0.34.”
In 2016, the Gini coefficient of wealth distribution in the US was 0.415. This suggests that the combination of parents’ stock market experience and subsequent parent-child interaction may go a long way towards explaining the wealth inequality phenomenon in the US and possibly elsewhere.
Z. Zhao and M. Cui show how our parents’ and grandparents’ experiences of the stock markets can affect wealth distribution and inequality. This provides policymakers with an opportunity to target policy interventions at reducing any negative impact. This might include policies aimed at making people feel more positive about stock markets, such as fiscal measures that increase investment returns directly or indirectly (such as capital gains taxes). Or it might involve improving financial literacy so that more people recognize the benefits of stock market participation.
Read the paper here.
Featured image by: © Rantasha | Dreamstime.com