Heterogeneous Idiosyncratic Risk and the Composition of Household Financial Portfolios

What explains differences in the composition of households' portfolios? Recent literature has focused on the effects of heterogeneous portfolios. This paper provides an explanation of differences in households' savings patterns that is consistent with micro-level data for the United States. I focus on the effect of heterogeneity in earnings risk to explain differences in the type of deposits. First, I find micro-evidence that relates differences in the maturity structure of households savings with earnings risk, where high idiosyncratic risk results in high demand for short-term liquid deposits, while low earnings risk allows agents to allocate a larger fraction of their assets in long-term illiquid deposits. Second, I present a continuous-time macroeconomic model with incomplete markets, heterogeneous agents, and two assets, where agents have heterogeneous demand for liquidity, driven by differences in earnings risk. The model reproduces differences in the composition of optimal portfolios, consistent with the empirical findings.