The influence of human capital and heterogeneous risk preferences on the demand for financial assets

This research examines the influence of human capital and heterogeneous risk preferences on household portfolio compositions. The data for this study come from the Michigan Panel Study of Income Dynamics (PSID). The results of the study indicate that individual household characteristics play a major role in the way households choose to allocate their financial wealth among competing investment alternatives.;To test the hypothesis that heterogeneous risk preferences explain the observed differences in portfolio compositions across households, consumption Euler equations are estimated for subsamples of households whose financial asset portfolios contain varying degrees of risk. Parameter estimates representing the Pratt-Arrow coefficient of relative risk aversion are obtained for each of the subsamples and are found to be twice as large for the subsample of households whose assets are defined as riskless or near riskless compared to the coefficient estimates for the subsample of households whose financial assets are comprised mainly of stocks. Although these estimates are consistent with the notion of heterogeneous risk preferences, only a portion of the observed differences in asset portfolios across households can be explained by differences in risk preferences.;The model is extended to consider the role of human capital on the household asset allocation decision. It is used to derive an equation that establishes a positive link between the portion of financial assets invested in the form of risky assets, and the value of each household's human capital. The dependence of portfolio composition on the value of each household's human capital, represented by household specific social and demographic variables, is estimated as a Tobit model using maximum likelihood. Variables that are known to be positively related to lifetime earnings such as educational attainment, hours worked and health are positively related to the fraction of each household's assets held as stocks. In contrast, households that experience longer periods of unemployment hold a smaller fraction of their portfolio in the form of stocks.