Why Do Household Portfolio Shares Rise in Wealth?

Abstract:     
In the cross-section of households, the portfolio share rises in wealth and is relatively stable in age. Life-cycle models with homothetic utility and non-tradable labor income have the counterfactual implication that the portfolio share falls in both wealth and age. We develop a life-cycle model in which households have nonhomothetic utility over two types of consumption goods, basic and luxury. The nonhomothetic life-cycle model predicts that the basic expenditure share falls in total consumption. When calibrated to match the cross-sectional variation in the basic expenditure share, this model explains the empirical evidence on portfolio choice.

Keywords: Decreasing relative risk aversion, Engel curves, Life-cycle model, Nonhomothetic utility, Portfolio choice

JEL Classifications: D11, D12, G11

Working Paper Series