Working Paper: CEPR ID: DP888
Authors: Luigi Guiso; Tullio Jappelli; Daniele Terlizzese
Abstract: Economic theory suggests that uninsurable income risk, health risk and the expectation of future borrowing constraints can reduce the share of risky assets in a household's portfolio. In fact, if its utility function exhibits decreasing absolute risk aversion and decreasing prudence, a household will reduce its exposure to avoidable risks when confronted with additional, independent unavoidable risks. If there are transactions costs associated with sales of illiquid and risky assets, the expectation of future borrowing constraints should induce households to keep a higher proportion of their wealth in the form of liquid and safe assets. To date, no empirical evidence has been cited in support of these theoretical claims. In this paper we use data from the 1989 Italian Survey of Household Income and Wealth to explore this issue. Using proxies for income risk, health risk and borrowing constraints, we find evidence that each of these variables significantly reduces the demand for risky assets.
Keywords: Portfolio choice; Earnings uncertainty; Liquidity constraints; Precautionary saving
JEL Codes: D81; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Income risk (G52) | Demand for risky assets (G19) |
| Borrowing constraints (F34) | Demand for risky assets (G19) |
| Health risk (I12) | Demand for risky assets (G19) |
| Income risk and Health risk (G52) | Demand for risky assets (G19) |