Income Hedging and Portfolio Decisions
70 Pages Posted: 9 Nov 2012 Last revised: 31 Jul 2013
Date Written: July 31, 2013
We examine whether the decision to participate in the stock market and other related portfolio decisions are influenced by income hedging motives. Economic theory predicts that the market participation propensity should increase as the correlation between income growth and stock market returns decreases. Surprisingly, empirical studies find limited support for the income hedging motive. Using a rich, unique Dutch dataset and the NLSY data from the U.S., we show that when the income-return correlation is low, individuals exhibit a greater propensity to participate in the market and allocate a larger proportion of their wealth to risky assets. Even when the income risk is high, individuals exhibit a higher propensity to participate in the market when the hedging potential is high. These findings suggest that income hedging is an important determinant of stock market participation and asset allocation decisions.
Keywords: income hedging, market participation, asset allocation, household finance
JEL Classification: G10, G11, G12
Suggested Citation: Suggested Citation