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Portfolio Allocation of Precautionary Assets: Panel Evidence for the United States

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  • Atreya Chakraborty

    ()
    (Brandeis University)

  • Mark Kazarosian

    ()
    (Boston College)

Abstract

Economic theory predicts that earnings uncertainty increases precautionary saving and causes households to include relatively liquid assets in their portfolios. Risk avoidance and the demand for liquidity cause these portfolio choices. Studies investigating United States evidence of precautionary portfolio allocation are nonexistent. With panel data, our results confirm the precautionary motive, and indicate that the desire to moderate total exposure to risk (temperance) and the demand for liquidity each affect the household's portfolio. Both permanent and transitory earnings uncertainty boost total wealth, and this precautionary wealth tends to be invested in safe, liquid assets. These results are particularly pronounced for people facing borrowing constraints. Such behavior is consistent with consumer utility functions that exhibit decreasing absolute risk aversion and decreasing strength of the precautionary motive (prudence). Our findings are important because both unemployment compensation and income taxes provide insurance that reduce earnings uncertainty. As a result, precautionary saving is both curtailed and reallocated. These policies could have large effects on capital formation and interest rates, through changes in the composition of household asset demand.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 432.

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Length: 37 pages
Date of creation: 30 Aug 1999
Date of revision:
Handle: RePEc:boc:bocoec:432

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Keywords: Precautionary Motive; Portfolio Allocation; Panel Data; Uncertainty; Prudence; Temperance; Liquidity Constraints;

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References

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Cited by:
  1. Stefan Hochguertel, 2003. "Precautionary motives and portfolio decisions," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 18(1), pages 61-77.
  2. Ji, Tingting, 2004. "Consumer Credit Delinquency And Bankruptcy Forecasting Using Advanced Econometrc Modeling," MPRA Paper 3187, University Library of Munich, Germany.
  3. Sule Alan, 2004. "Precautionary Wealth and Portfolio Allocation: Evidence from Canadian Microdata," Social and Economic Dimensions of an Aging Population Research Papers 117, McMaster University.

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