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Countercyclical Risks, Consumption, and Portfolio Choice: Theory and Evidence

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  • Jialu Shen

    (Trulaske College of Business, University of Missouri, Columbia, Missouri 65201)

Abstract

Using a quantitative, calibrated life-cycle model, I show that countercyclical earnings risk affects individual consumption growth, reduces the share of wealth in stocks, and affects savings behavior. Using the Panel Study of Income Dynamics survey, I construct an empirical measure of countercyclical earnings risk and find evidence consistent with the model’s predictions. Specifically, larger downside earnings risk decreases consumption growth, increases left skewness in consumption growth, and reduces the share of wealth in stocks. Furthermore, the consumption effects are substantially more significant for stockholders than for nonstockholders, which arises through heterogeneity in the elasticity of intertemporal substitution.

Suggested Citation

  • Jialu Shen, 2024. "Countercyclical Risks, Consumption, and Portfolio Choice: Theory and Evidence," Management Science, INFORMS, vol. 70(5), pages 2862-2881, May.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:5:p:2862-2881
    DOI: 10.1287/mnsc.2023.4837
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