Household Constraints and Financial Decisions

56 Pages Posted: 6 Nov 2020 Last revised: 16 Nov 2020

See all articles by Woon Sau Leung

Woon Sau Leung

The University of Edinburgh Business School, The University of Edinburgh

Zhongyan Zhu

Monash University

Date Written: October 9, 2020

Abstract

We introduce debt-wealth constraints to analyze the financial decisions of typical households. Unlike an unconstrained household in normative finance, a constrained household is indebted with limited wealth. Due to binding debt repayments, a constrained household is conservative in risk tolerance and chooses not to engage risky investments or withdraws earlier than does an unconstrained unit. Empirically, we test differential financial decisions through fixed income mutual fund data. When funds deliver below-average returns, conservative investors withdraw, whereas those with aggressive risk tolerance keep risky engagements. Flows to funds with high-risk exposure are significantly larger than funds with low-risk exposure.

Keywords: Household Finance; Limited Participation in Risky Equity; Condition for Mean-Variance Optimization; Fixed-Income Mutual Fund; Fund Flows

JEL Classification: G20; G23; G28

Suggested Citation

Leung, Woon Sau and Zhu, Zhongyan, Household Constraints and Financial Decisions (October 9, 2020). Available at SSRN: https://ssrn.com/abstract=3720229 or http://dx.doi.org/10.2139/ssrn.3720229

Woon Sau Leung

The University of Edinburgh Business School, The University of Edinburgh ( email )

29 Buccleuch Pl
Edinburgh, Scotland EH8 9JS
United Kingdom

Zhongyan Zhu (Contact Author)

Monash University ( email )

Melbourne
Australia

HOME PAGE: http://sites.google.com/site/zhougyanzhu/

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