Heterogeneous Background Risks and Portfolio Choice: Evidence from Micro-Level Data

Abstract

We construct a set of household-level background risk variables to capture the covariance structure of three nonfinancial assets and two financial assets. These risks are in general statistically significant and economically important for a household’s stock market participation and stock holdings. A one standard deviation increase in background risks reduces the participation probability by 11% and the stock holdings to wealth ratio by 4%. The volatilities of labor income, housing value, and business income reduce a household’s participation and stock holdings. A household with labor income highly correlated with stock (bond) returns is less (more) likely to invest in stock.

Keywords: background risks, stock market participation, portfolio choice, asset returns

JEL Classification: G11, C25