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What is the impact of wealth shocks on asset allocation?

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  • Ricardo M. Sousa

Abstract

I test the assumption of constant relative risk aversion using U.S. macroeconomic data and analyse the role of wealth shocks in generating transitory changes in asset portfolio composition. I show that the risky asset share exhibits cyclical behavior and it is significantly (and positively) affected by unexpected variation in wealth. Therefore, the empirical evidence suggests that risk aversion is counter-cyclical. I also find that the portfolio share of housing wealth falls when the agent is faced with a positive wealth shock, i.e. housing is a hedge against unfavorable wealth fluctuations. Finally, considering a variety of wealth definitions, the results show that: (i) wealth effects are stronger for direct holdings of risky assets than for indirect holdings, which highlights that investors do not typically trade some assets such as pension or mutual funds; (ii) although significant, wealth effects on asset allocation are mainly temporary as agents quickly rebalance the asset portfolio composition (i.e. there is weak evidence of inertia or slow adjustment in asset allocation); and (iii) changes in expected returns partially explain the variation in risky asset allocation.

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  • Ricardo M. Sousa, 2015. "What is the impact of wealth shocks on asset allocation?," Quantitative Finance, Taylor & Francis Journals, vol. 15(3), pages 493-508, March.
    • Handle: RePEc:taf:quantf:v:15:y:2015:i:3:p:493-508
    DOI: 10.1080/14697688.2011.647053
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    References listed on IDEAS

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    1. Vitor Castro, 2013. "The duration of business cycle expansions and contractions: are there change-points in duration dependence?," Empirical Economics, Springer, vol. 44(2), pages 511-544, April.
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    Cited by:

    1. João M. Sousa & Ricardo M. Sousa, 2019. "Asset Returns Under Model Uncertainty: Evidence from the Euro Area, the US and the UK," Computational Economics, Springer;Society for Computational Economics, vol. 54(1), pages 139-176, June.
    2. Christou, Christina & Gupta, Rangan & Jawadi, Fredj, 2021. "Does inequality help in forecasting equity premium in a panel of G7 countries?," The North American Journal of Economics and Finance, Elsevier, vol. 57(C).
    3. Mehmet Balcilar & Rangan Gupta & Ricardo M. Sousa & Mark E. Wohar, 2021. "What Can Fifty-Two Collateralizable Wealth Measures Tell Us About Future Housing Market Returns? Evidence from U.S. State-Level Data," The Journal of Real Estate Finance and Economics, Springer, vol. 62(1), pages 81-107, January.
    4. Wang, Guocheng & Wang, Yanyi, 2018. "Herding, social network and volatility," Economic Modelling, Elsevier, vol. 68(C), pages 74-81.
    5. Sousa, João & Sousa, Ricardo M., 2017. "Predicting risk premium under changes in the conditional distribution of stock returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 50(C), pages 204-218.
    6. Costantini, Mauro & Maaitah, Ahmad & Mishra, Tapas & Sousa, Ricardo M., 2023. "Bitcoin market networks and cyberattacks," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 630(C).
    7. Luca Agnello & Vitor Castro & Ricardo M. Sousa, 2015. "Booms, Busts, and Normal Times in the Housing Market," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 33(1), pages 25-45, January.
    8. Fredj Jawadi & Ricardo M. Sousa, 2012. "Consumption and Wealth in the US, the UK and the Euro Area:A Nonlinear Investigation," NIPE Working Papers 24/2012, NIPE - Universidade do Minho.

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