Why Do Household Portfolio Shares Rise in Wealth?

Abstract

We develop a life-cycle consumption and portfolio choice model in which households have nonhomothetic utility over two types of goods, basic and luxury. We calibrate the model to match the cross-sectional and life-cycle variation in the basic expenditure share in the Consumer Expenditure Survey. The model explains the degree to which the portfolio share in risky assets rises in wealth in the cross-section of households in the Survey of Consumer Finances. For a given household, the portfolio share can fall in response to an increase in wealth, even though the model implies decreasing relative risk aversion. (JEL D11, D12, G11) Surveys of household finances reveal a striking fact: The share of wealth invested in stocks, or risky assets more generally, rises in wealth. While poorer households are less likely to participate in the stock market, this fact alone does not explain the positive relation between wealth and the share of wealth invested in stocks (hereafter, the portfolio share). The portfolio share rises in wealth even among stockholders. While more highly educated households tend to have higher portfolio shares, the portfolio share rises in wealth even among stockholders with the same education level. This article examines the role that nonhomothetic utility plays in explaining the observed relation between portfolio choice and wealth. We develop a life-cycle model in which the household consumes two types of goods. The household’s utility function has higher curvature over a “basic good” than over