Household Portfolio Research Articles

Rich Pickings? Risk, Return, and Skill in the Portfolios of the Wealthy

This paper empirically investigates the portfolios of wealthy households and their implications for the dynamics of inequality. Using an administrative panel of all Swedish residents, we document that returns on financial wealth are on average 4% higher per year for households in the top 1% compared to the median household. These high average returns are primarily compensations for high levels of systematic risk. Abnormal risk-adjusted returns, linked for instance to informational advantages or exceptional investment skill, contribute only marginally to the high returns of the wealthy. Implications for inequality dynamics and public policy are discussed.

Livelihoods Limitations: The Political Economy of Urban Poverty in Dhaka, Bangladesh

ABSTRACTResearch in Bangladesh reveals the limitations of actor‐oriented frameworks for understanding urban poverty that assess household livelihoods on the basis of a household's portfolio of assets or capitals. The narrow focus of these frameworks on households and their depoliticized definition of social capital overlook the political roots of urban poverty. The informal systems of governance that dominate resource distribution within low‐income settlements ensure that the social resources necessary for long‐term household improvement are confined to a small elite. Only through extending our analysis beyond the household level, to explore their position within this local political economy of employment and enterprise, can we recognize the limitations placed on household efforts to improve their livelihoods.

Why Do Households with Risky Labor Income Take Greater Financial Risks?

US households with high unconditional and cyclical labor income risk are more leveraged and allocate a greater share of their financial assets to stocks. I use self-reported risk preferences to show that rational sorting of risk tolerant workers into risky employment is responsible for this otherwise puzzling result. With risk preferences accounted for, the evidence suggests that households with greater permanent income variance reduce leverage and stock allocations to an extent consistent with theory. However, household portfolios and employment selection do not respond significantly to any of the other three forms of labor income risk I measure: disaster risk, permanent income cyclicality, and permanent income variance cyclicality.

Buffer stock savings by portfolio adjustment: evidence from rural India

AbstractThe empirical literature on household savings tends to treat savings simply as the residual of income minus consumption. This article takes a unique approach to reconstruct the cash and asset balances using detailed household transaction data on farm households in rural India and generates monthly and seasonal ICRISAT panel data for the period 1976–1983. We have found that households—irrespective of their landholding status—cope with temporary shocks quite well by using crop inventory, currency, and capital assets, rather than livestock, as buffer assets. The importance of portfolio adjustments in smoothing consumption is also confirmed by the use of a system of equations in which both portfolio and production decisions are made endogenous. It is concluded that not only the level but also the diversification of household assets are important for buffering consumption. As an extension, we have explored the monthly ICRISAT panel data for the period 2009–2012 in the same villages and have found a similar pattern in household portfolio responses to income shocks.

The Portfolio Balance Channel of Monetary Policy: Evidence from the U.S. Financial Accounts

How does monetary policy affect the balance sheet of households? This is an important question in light of the recent large scale asset purchases that have been justified on the grounds of the portfolio balance channel. Many studies have attempted to quantify the effect of these LSAPs and find evidence for the portfolio channel. Most of these studies, however, focus only on one manifestation of the portfolio channel, the change in relative yields and typically do so in the narrow context of the zero lower bound. Little is empirically known about this channel in more conventional settings. This paper attempts to fill this gap in the literature by examining the overall validity of the channel away from the zero lower bound. We do this by examining how household portfolios responded to monetary policy shocks to the monetary base and to inflation forecasts for the period 1959:Q1 – 2007:Q4. We find strong evidence that the portfolio channel is an important part of the monetary transmission mechanism.

Household Portfolio Choice and Human Capital: The Importance of the Persistence of Labor Income Shocks

Using longitudinal data from PSID, we show the positive relation between labor income and the equity share of financial wealth is stronger for those who have a higher persistence in shocks to permanent labor income. The results support the hypothesis that the cross sectional variation in persistence captures latent human capital effects on investment decisions, without which the variation in equity share appears to be attributed to variation in financial wealth. The predictions, which are supported empirically, are formulated with a simple model and a realistically calibrated life-cycle model of consumption and portfolio choice with non-tradeable human capital.

The risk premium and long-run global imbalances

This study proposes that heterogeneous household portfolio choices within a country and across countries offer an explanation for global imbalances. We construct a stochastic growth multi-country model in which heterogeneous agents face the following restrictions on asset trade. First, the degree of US equity market participation is higher than that of the rest of the world. Second, a fraction of households in each country maintains a fixed share of equity in its portfolios. In our calibrated model, which matches the US net foreign asset position and the equity premium, the average US household loads up more aggregate risk than the average foreign household by investing in risky assets abroad and issuing risk-free assets. As a result, the US is compensated by a high risk premium and runs trade deficits even as a debtor country. The long-run average trade deficit in our model accounts for 50% of the observed US trade deficit.

The Risk Premium and Long-Run Global Imbalances

This study proposes that heterogeneous household portfolio choices within a country and across countries offer an explanation for global imbalances. We construct a stochastic growth multi-country model in which heterogeneous agents face the following restrictions on asset trade. First, the degree of US equity market participation is higher than that of the rest of the world. Second, a fraction of households in every country maintains a fixed share of equity in their portfolios. In our calibrated model, which matches the US net foreign asset position and the equity premium, the average US household loads up more aggregate risk than the average foreign household by investing in a risky asset abroad and issuing a risk-free asset. As a result, the US is compensated by a high risk premium and runs trade deficits even as a debtor country. The long-run average trade deficit in our model accounts for more than 50% of the observed US trade deficit.

The impact of the recession on the wealth of older immigrant and native households in the United States

Abstract Using the 2006 and 2010 Health and Retirement Study, we explore how the recent recession impacted the wealth holding and retirement plans of older households in the United States. Of particular interest to us is whether the impact on household asset ownership, asset wealth and household retirement behavior varied with the nativity of the household and its standing in the wealth distribution prior to the onset of the recession. We find that the so-called Great Recession made a significant dent on the portfolios of older American households by eroding the value of specific assets to the point of delaying their planned retirement. Furthermore, its impacts were unevenly distributed across demographic and economic groups, with mixed and immigrant households in the middle and top wealth quartiles prior to the recession enduring significantly larger wealth losses than natives due, primarily, to their greater losses in primary housing ownership and primary housing values. JEL codes: D31; J26

How Does Household Portfolio Diversification Vary with Financial Sophistication and Advice?

Household investment mistakes are an important concern for researchers and policymakers alike; portfolio underdiversification ranks among those mistakes that are potentially most costly. However, its roots and empirical importance are poorly understood. I estimate quantitatively meaningful diversification statistics and investigate their relationship with key variables. Nearly all households that either score high on financial literacy; or rely on professionals or private contacts for advice; achieve reasonable investment outcomes. Compared to these groups, households with below-median financial literacy that trust their own decision-making capabilities, lose an expected 50bp on average. All group differences stem from the top of the loss distribution.

How Does Household Portfolio Diversification Vary with Financial Literacy and Financial Advice?

ABSTRACTHousehold investment mistakes are an important concern for researchers and policymakers alike. Portfolio underdiversification ranks among those mistakes that are potentially most costly. However, its roots and empirical importance are poorly understood. I estimate quantitatively meaningful diversification statistics and investigate their relationship with key variables. Nearly all households that score high on financial literacy or rely on professionals or private contacts for advice achieve reasonable investment outcomes. Compared to these groups, households with below‐median financial literacy that trust their own decision‐making capabilities lose an expected 50 bps on average. All group differences stem from the top of the loss distribution.

Migration and Climate Change in Rural Africa

We analyse whether migration is an adaptation that households employ to cope with climate in Ghana and Nigeria. If migration is part of the present adaptation portfolio of households in developing countries, it is reasonable to expect that it will also be an adaptation to future climate change. It is important to stress that we are interested in long-term climatic conditions rather than in short-term weather fluctuations. The data to test these predictions are drawn from two different household surveys: the Nigeria General Household Survey and the Ghana Living Standard Survey. We find a hill-shaped relationship between temperature in the dry sea son and the propensity to migrate in households that operate farms. We also find a significant hill-shaped relationship between precipitations in the wet seasons and the propensity to migrate in farm households. Climate has instead no significant impact on the propensity to migrate in non-farm households. Climate change scenarios generated by General Circulation model reveal that, ceteris paribus, migration may decline in Ghana and in Nigeria.

Is Financial Fragility a Matter of Illiquidity? An Appraisal for Italian Households

We investigate household financial fragility in Italy, providing three main contributions. First, we propose a novel characterization of financial fragility that is not necessarily linked to indebtedness, distinguishes between expected and unexpected expenses, takes portfolio composition into account, and is free of subjectivity bias. Second, we use it to assess the importance of household portfolio composition for determining the difficulties related to coping with unexpected expenditures, besides socio‐economic and demographic factors. Third, we test its ability to forecast future conditions of financial distress. The empirical analysis is based on the Bank of Italy Survey on Household Income and Wealth. The results highlight the relevance of portfolio choices as determinants of financial distress, that is, they provide evidence that homeownership increases the likelihood of financial fragility while the presence of a mortgage decreases it. Moreover our measure is shown to act as an early warning indicator of distress.

The Potential Role of Housing Equity in a Looming Baby Boomer Retirement Cash-flow Crisis: An Australian Perspective

With Australia’s 5.5 million “baby boomer” generation and tens of millions of others around the world now transitioning into retirement, government and community resources for the developed world’s rapidly ageing populations are increasingly stretched. A key emerging problem is that some retirees do not have sufficient asset liquidity to finance post-retirement consumption needs. This is seemingly despite households holding substantial assets in the form of housing equity in many countries. The family home has the potential to change from a direct investor private financial asset to a more flexible, securitized, financial instrument. The purpose of this paper was to examine the role of housing equity in supporting retirement consumption and income needs and easing financial stress in later retirement. The paper also examines the potential for new financial instruments tailored for retirees seeking to decumulate housing equity at low cost. Incorporating panel data from the Household, Income and Labour Dynamics in Australia (HILDA) Survey, we illustrate the role of housing in Australian household portfolio composition in particular and the experience of homeownership for different Australian households, with the primary objective being to identify issues that affect home equity decumulation.

Endogenous Credit Constraints and Household Portfolio Choices

In this paper we develop a consumption and portfolio selection model for a household with borrowing constraints endogenized by limited enforcement of debt repayment. By using a duality approach, we provide explicit solutions for endogenous credit limits and consumption and portfolio policies. We derive theoretical implications for unsecured credit limits. Most noteworthy is the finding that a better investment opportunity implied by a higher Sharpe ratio increases the shares of investment in risky assets of the rich but decreases the shares of the poor. This is due to changes in credit limits according to a change in the Sharpe ratio. We also provide empirical evidence for our theoretical results by using the Survey of Consumer Finances.

Migration and Climate Change in Rural Africa

We analyse whether migration is an adaptation that households employ to cope with climate in Ghana and Nigeria. If migration is part of the present adaptation portfolio of households in developing countries, it is reasonable to expect that it will also be an adaptation to future climate change. It is important to stress that we are interested in long-term climatic conditions rather than in short-term weather fluctuations. The data to test these predictions are drawn from two different household surveys: the Nigeria General Household Survey and the Ghana Living Standard Survey. We find a hill-shaped relationship between temperature in the dry sea son and the propensity to migrate in households that operate farms. We also find a significant hill-shaped relationship between precipitations in the wet seasons and the propensity to migrate in farm households. Climate has instead no significant impact on the propensity to migrate in non-farm households. Climate change scenarios generated by General Circulation model reveal that, ceteris paribus, migration may decline in Ghana and in Nigeria.

Risk Preferences of Australian Households: A Panel Study

Using household panel data for Australia sourced from HILDA, we explore how household risk preferences in relation to portfolio holdings differ across wealth ranges and in relation to various household sociodemographic characteristics across the nation. Our measure of risk is based on the proportion of variance of the optimal household portfolio rather than the proportion of risky assets in the portfolio. Based on this measure, we estimate the coefficients of relative risk aversion for investors in various wealth ranges. In contrast to most studies, we find evidence of very high risk aversion amongst the majority of households. However, this is heavily concentrated amongst less wealthy households. We apply a first differences model across three survey waves spanning 2002 to 2010, and focus on the aggregate national level. We find that risk tolerance increases significantly with household wealth, the relationship is both statistically and economically significant. Liquidity contraints in the form of rental payments were found to diminish household appetite for risk. However, risk tolerance is positively associated with mortgage payments.

Trading death: The implications of annuity replication for the annuity puzzle, arbitrage, speculation and portfolios

Annuities are perceived as being illiquid financial instruments, and this has limited their attractiveness to consumers and their inclusion in financial models. However, short positions in annuities can be replicated using life insurance and debt, permitting long positions in annuities to be offset, or short annuity positions to be created. The implications of this result for the annuity puzzle, arbitrage between the annuity and life insurance markets, and speculation on expected longevity are investigated. It is argued that annuity replication could help reduce the annuity puzzle, improve the price efficiency of annuity markets and promote the inclusion of annuities in household portfolios.

Household finances and the ‘Big Five’ personality traits

Using data drawn from the British Household Panel Survey, we analyse the relationship between personality traits and financial decision-making focusing on unsecured debt and financial assets. Personality traits are classified according to the ‘Big Five’ taxonomy: openness to experience, conscientiousness, extraversion, agreeableness and neuroticism. We explore personality traits at the individual level and also within couples, specifically the personality traits of the head of household and personality traits averaged across the couple. We find that certain personality traits such as extraversion are generally significantly associated with household finances in terms of the levels of debt and assets held and the correlation is often relatively large. The results also suggest that the magnitude and statistical significance of the association between personality traits and household finances differs across the various types of debt and assets held in the household portfolio.

Signaling Status: The Impact of Relative Income on Household Consumption and Financial Decisions

This paper investigates the importance of status in household consumption and financial decisions using household data from the Survey of Consumer Finances (SCF) linked to neighborhood data in the American Community Survey (ACS). We find evidence that a household's income rank — its position in the income distribution relative to its close neighbors — is positively associated with its expenditures on high status cars, its level of indebtedness, as well as the riskiness of the household's portfolio. More aggregate county-level evidence based on a dataset of every new car sold in each county in the United States since 2002 also suggests that the signaling motive might be important. These results indicate that greater income heterogeneity might have large consequences for household consumption and portfolio decisions.