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Does Relative Risk Aversion Vary with Wealth? Evidence from Households' Portfolio Choice Data

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In this article, we explore whether relative risk aversion varies with wealth. First, we derive theoretical predictions on how risky shares respond to wealth uctuations in a portfolio choice model with both external habits and time-varying labor income. Our analytical results indicate that: (1) for each household, there are two channels through which the risky share responds to wealth uctuations, the habit channel and the income channel; (2) across households, there are heterogeneous responses through the habit channel: those who experience large negative income shocks reduce their share of risky assets; and (3) two potential mis-identi cation problems arise when both the heterogeneity in responses through the habit channel and the income channel are ignored. We then test the theoretical predictions with data from the Panel Study of Income Dynamics. Contrary to the existing literature, our empirical ndings show evidences of relative risk aversion varying with wealth over time after correcting those two mis-identi cation problems.

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  • Fang Yang & Xuan Liu & Zongwu Cai, 2013. "Does Relative Risk Aversion Vary with Wealth? Evidence from Households' Portfolio Choice Data," Departmental Working Papers 2013-09, Department of Economics, Louisiana State University.
  • Handle: RePEc:lsu:lsuwpp:2013-09
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    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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