The Financial Markets and Wealth Effects on Consumption: an Experimental Analysis

The paper investigates the effects exerted by the ownership of quoted equities on intertemporal wealth allocation. To this end, it reports an experiment conducted with human subjects. The fact that an increasing share of household balances is allocated to equities raises numerous questions on the nature and magnitude of so-called ‘wealth effects’. The traditional theories are based on the assumption of perfect rational agents and do not consider wealth effects in detail. The empirical literature on the topic is heterogeneous and does not give a uniform description of such effects. The decision to work with experimental tools was prompted by the idea that this approach would shed light on the behaviour of subjects asked to decide on simulated consumption/saving decisions. The neutral position taken up with respect to the traditional theory when designing the experiment enabled us to compare the outcomes of the laboratory experiment against the theoretical findings of Hall's (1978) model, which describes a Random Walk in consumption. This analysis yielded a much more complex picture than would have been obtained in the perfect rationality framework which supports the traditional theories of life cycle-permanent income. In trying to understand and give a theoretical framework to the behaviour observed in the laboratory, we consider models taken from both the economic and the psychological literature. The analysis furnishes interesting insights, which are described and considered as future directions for research.