The Impact of Economic Uncertainty on Household Portfolio Choice: Evidence from China

Abstract

This paper provides micro-level evidence on the effects of economic uncertainty on household portfolio choices driven by precautionary motives. We propose a conceptual framework illustrating how increased economic uncertainty—through heightened volatility in financial asset returns and tighter credit constraints—reduces household participation in risky asset investments while promoting a shift toward risk-free assets. Using region-level economic uncertainty indices and household-level portfolio data from China, we empirically confirm these theoretical predictions. To address potential endogeneity, we employ the U.S. economic uncertainty index as an instrumental variable, yielding consistent and statistically significant results. Additionally, we find that economic uncertainty has a more pronounced effect on portfolio allocation among households with higher levels of education and financial literacy, as these households are more attuned to financial risks. This study contributes to the literature by providing robust micro-level evidence on how economic uncertainty influences household financial decision-making.

Keywords: Economic Uncertainty, Portfolio Choice, Risky Assets, Return Volatility, Credit Constraint