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

Listed author(s):
  • Atreya Chakraborty

    ()

    (Brandeis University)

  • Mark Kazarosian

    ()

    (Boston College)

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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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
Handle: RePEc:boc:bocoec:432
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