Borrowing Constraints, Portfolio Choice, and Precautionary Motives: Theoretical Predictions and Empirical Complications
39 Pages Posted: 25 Sep 1998
Date Written: October 19, 1999
Abstract
This paper studies effects of income-based and collateral borrowing constraints on wealth accumulation and portfolios. We compare unconstrained and constrained behavior for different types of constraints and degrees of tightness. Income-based constraints can reduce or eliminate effects of earnings risk on wealth accumulation by constraining wealth adjustments to such risk. They can also reverse effects of risk aversion and of temperance on stockholding relative to those obtained in unconstrained models. Analogous results hold for collateral constraints, where risky assets play the dual role of portfolio component and of collateral. Thus, samples containing borrowing-constrained households are likely to underplay or even reverse the impact of risk aversion and of earnings risk expected on the basis of unconstrained models. This may help explain the failure of empirical studies to uncover sizeable precautionary effects on wealth and on portfolios.
JEL Classification: G11, E21
Suggested Citation: Suggested Citation
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