How risk-adverse individuals make investment decisions that optimize their risk return reward has been the centerfold of modern portfolio choice theory. Despite a large body of research, there is a lack of consensus between theory, empirical evidence, and popular recommendations of financial advisors. The goal of the research outlined in this proposal is to reconcile theory and observation. To this end, we aim to build knowledge and offer insights on the interaction between variations in individuals’ financial risk-taking decisions and the heterogeneity in their labor income risk, i.e. the uncertainty of their human-capital income that directly affects consumption.
How does human capital affect the demand for risky assets in the economy? Can accounting for the nature of human capital help gain insight into the sources of limited stock market participation? What is the effect of the labor income channel on portfolio allocations of the participating investors?