Households make financial decisions along two main dimensions. They decide how to allocate their income between consumption and savings and how to allocate their savings between risky and risk-free assets. The literature often models such decisions using a unitary framework, which treats the house hold as a single decision-making unit with one utility function and pooled income. A limitation of this approach is that it cannot analyze the influence of individual household members with different preferences on household financial decisions. Papers that do allow household members to have separate preferences have shown that this is an important consideration. For example, Browning (2000) and Mazzocco (2004) find that the allocation of resources within the household affects the consumption-savings decision when spouses differ in their preferences. Empirical estimates show that a majority of spouses do indeed differ in risk preferences (Barsky, Juster, Kimball, and Shapiro, 1997; Kimball, Sahm, and Shapiro, 2008).
This paper focuses on the household’s decision to allocate its savings between risky and risk-free assets (hereafter household portfolio choice or allocation). As economic changes place greater responsibility on households to manage their own portfolios, it has become increasingly important for economists and policy makers to understand how households make this decision.
The literature on household portfolio choice is vast. The benchmark model, which treats the household as a single agent with constant relative risk aversion, predicts that household portfolio choice is independent of wealth. Yet, empirical evidence suggests that the share of the household portfolio allocated to risky assets increases with wealth (Bertaut and Starr-McCluer, 2002) and that the risk preferences of individual members are a significant determinant of household portfolio choice (Charles and Hurst, 2003; Barsky, Juster, Kimball, and Shapiro, 1997; Kimball, Sahm, and Shapiro, 2008).
This paper provides a model of household portfolio choice that is consistent with this evidence. The model illustrates how intra-household differences in risk aversion and bargaining power interact with wealth to determine household portfolio choice. The model predicts that the risk aversion of the spouse with more bargaining power determines household portfolio allocation. The model also predicts that the share of risky assets in the household portfolio increases with household wealth.
The predictions of the model are tested using data from the Health and Retirement Study (HRS). The HRS is a longitudinal study that has surveyed older Americans every other year since 1992. The HRS includes detailed information on household portfolios and a series of questions that can be used to infer respondents’ risk aversion. Preliminary empirical evidence suggests that the predictions of the model are consistent with the data.
