Portfolio choice and asset pricing with non-homothetic preferences

Abstract

I estimate the structural parameters of a life-cycle consumption and portfolio choice model with non-homothetic risk preferences and study the quantitative implications of decreasing relative risk aversion for inequality and asset pricing. The model matches empirical patterns in portfolio allocations with a significant degree of nonhomotheticity in risk preferences, such that a 10% permanent income growth leads to a decrease in risk aversion by 1.9%. Decreasing relative risk aversion in the model doubles the share of wealth at the top, as equity is concentrated in the hands of the wealthy. The model also implies that rising income inequality in the U.S. has led to a 14% decline in the equity premium over the past three decades. Finally, I find that the model implications of time-varying risk aversion for the dynamics of asset prices are quantitatively limited.