Borrowing Constraints, Portfolio Choice, and Precautionary Motives: Theoretical Predictions and Empirical Complications

39 Pages Posted: 25 Sep 1998

See all articles by Christis Hassapis

Christis Hassapis

University of Cyprus

Michael Haliassos

Goethe University Frankfurt - Faculty of Economics and Business Administration; CEPR; NETSPAR; Goethe University Frankfurt - Institute for Monetary and Financial Stability (IMFS)

Date Written: October 19, 1999

Abstract

This paper studies effects of income-based and collateral borrowing constraints on wealth accumulation and portfolios. We compare unconstrained and constrained behavior for different types of constraints and degrees of tightness. Income-based constraints can reduce or eliminate effects of earnings risk on wealth accumulation by constraining wealth adjustments to such risk. They can also reverse effects of risk aversion and of temperance on stockholding relative to those obtained in unconstrained models. Analogous results hold for collateral constraints, where risky assets play the dual role of portfolio component and of collateral. Thus, samples containing borrowing-constrained households are likely to underplay or even reverse the impact of risk aversion and of earnings risk expected on the basis of unconstrained models. This may help explain the failure of empirical studies to uncover sizeable precautionary effects on wealth and on portfolios.

JEL Classification: G11, E21

Suggested Citation

Hassapis, Christis and Haliassos, Michael, Borrowing Constraints, Portfolio Choice, and Precautionary Motives: Theoretical Predictions and Empirical Complications (October 19, 1999). Available at SSRN: https://ssrn.com/abstract=131452 or http://dx.doi.org/10.2139/ssrn.131452

Christis Hassapis

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
1678 Nicosia
Cyprus
+357-2-892116 (Phone)
+357-2-750310 (Fax)

Michael Haliassos (Contact Author)

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
PF H32
Frankfurt am Main, D-60323
Germany

CEPR

London
United Kingdom

NETSPAR ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Goethe University Frankfurt - Institute for Monetary and Financial Stability (IMFS) ( email )

Theodor-W.-Adorno-Platz 1
Frankfurt, 60323
Germany