Precautionary Motives and Portfolio Decisions

Abstract

Theory predicts that under certain restrictions on preferences prudent consumers will allocate relatively more funds to riskless assets when there is uninsurable background risk. This paper analyzes empirically the relevance of precautionary motives for the structure of household wealth. To this end, a new and rich data source from the Netherlands is exploited. The question of primary concern is: what impact, if any, does the presence of income uncertainty have on the structure of Dutch households' portfolios? We employ various semi{parametric estimators, both for cross{sections and for panel data to assess the response of households' portfolios to uninsurable background risk. We find some, but not unanimous support for the view that portfolios become less risky as income uncertainty increases.precautionary saving;background risk;household saving;portfolio choice;application of LDV models