Angrisani, M.; (2011) Essays on household finance. Doctoral thesis , UCL (University College London).

Abstract

This thesis comprises three essays on household finance. It provides a comprehensive investigation of the role of heterogeneity in household circumstances to explain observed saving and investment decisions and to define a unified analytical framework to study such behaviours. Particular emphasis is placed on idiosyncratic, non-tradeable and non- diversifiable risks as determinants of financial choices over the life cycle. Another salient feature of the present contributions is their focus on retirement age individuals. In the context of the aging population, this large cohort has received particular attention given its relatively short retirement planning horizon, its greater vulnerability to market returns and shocks to retirement wealth, and its rising exposure to health risk. Advancing our understanding of middle-aged individuals' saving and investment decisions is essential towards the design of effective interventions aimed at enhancing their financial security at older ages. In Chapter 1 I provide a summary and overview of the thesis. In Chapter 2 I empirically investigate whether, when markets are incomplete, the presence of idiosyncratic uninsurable and non-diversifiable risks induces more prudent investment strategies and causes individuals to hold safer portfolios. In particular, I consider public pension uncertainty stemming from unexpected earnings variation as a source of background risk for workers before retirement. I find evidence of risk substitutability, in that individuals facing higher pension variability (background risk) reduce their exposure to stock market risks (endogenously controlled risks). In view of these findings, I develop in Chapter 3 a life-cycle model that reproduces the main sources of uncertainty confronted by households on the verge of retirement. These include unexpected earnings and pension variations, adverse health shocks, medical expenditure risk and survival uncertainty. I use this rich analytical set-up to study optimal retirement saving and portfolio choices and to evaluate the impact on household welfare of tax-deferred retirement accounts. The model generates plausible wealth accumulation and portfolio patterns. The degree of exposure to background risks, its evolution over time and interaction with tax incentives and liquidity constraints on retirement savings play a major role in shaping lifetime investment behaviour. In Chapter 4 I examine the effect of cognition and numeracy on a wide range of household financial outcomes. The results suggest that the degree of sophistication required to access more complex financial products may represent a severe barrier for less skilled individuals and that simple preference heterogeneity is not sufficient to explain observed differences in portfolio choice among investors with different abilities. Hence, policy interventions aimed at simplifying financial decision-making should be conceived as attempts to address informational or market failures. Such measures might eliminate or reduce the barriers preventing those with cognitive impairment from accessing certain investment opportunities and attaining the desired financial security.

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