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Precautionary saving, financial risk and portfolio choice

Listed author(s):
  • M. Deidda


Relying on a direct question about the desired amount of precautionary wealth from the 2002 wave of the Italian Survey of Household Income and Wealth, I assess the main determinants of precautionary motive for saving. In particular, I focus on the role played by financial risk on households' saving decisions. Actually, households investing mainly in safe assets do not need to protect themselves against future and unexpected financial losses. Consequently, controlling for households' sources of risk beside financial ones, the amount of precautionary savings of a household who invest exclusively in safe assets should be lower compared to households who instead detain a non-negligible share of risky assets in their portfolio. Moreover, portfolio diversification, reducing households' total exposure to financial risk, should reduce the amount of wealth households need to save for precautionary reasons. In this paper, I provide an empirical assessment of the linkage existing between the composition of households' portfolio and the amount of wealth households wish to have to protect themselves against unexpected contingencies. As expected, a strong and negative correlation exists between the desired amount of precautionary wealth and the ownership of a portfolio made exclusively of safe assets. However, households do not seem to use portfolio diversification to reduce exposure to total risk. Finally, I address the issue of complementarity vs. substitution between formal and informal insurance schemes. Actually, trust in capital market would lower substantially the amount of wealth households wish to detain for precautionary reasons. However, there is no evidence in favour of a negative and strong linkage between precautionary saving and insurance.

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Paper provided by Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia in its series Working Paper CRENoS with number 201001.

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Date of creation: 2010
Handle: RePEc:cns:cnscwp:201001
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