| Popis: |
Personal projects, such as a private business or the purchase of a home, influence individuals' portfolio choice. We conduct a theoretical analysis of this influence when financial assets are required to provide liquidity to personal projects. Due to this liquidity consideration, individuals behave in a more risk-averse fashion when there is a large penalty for discontinuing or underinvesting in the final stages of the projects. In addition, using data from the 1995 Survey of Consumer Finances, we find that households that are saving to invest in their own businesses or in their own homes indeed have significantly safer financial portfolios. A LARGE PORTION OF PRIVATE ASSETS are invested in personal illiquid projects. These are projects that must be partly self-financed and are costly to sell. According to the 1995 Survey of Consumer Finances (SCF), residential housing and capital invested in unincorporated businesses account for 41.2 percent and 19.1 percent, respectively, of household wealth.' In this paper, we study the impact of these personal illiquid projects on individuals' portfolios of financial assets. Personal projects influence portfolio choice in two ways. First, financial assets can be used to provide diversification against bad outcomes of personal projects. This interaction is well recognized in the literature as it emanates from standard portfolio theory. Second, financial assets can be used to provide liquidity to personal projects when the timing of investment in these projects is important. This latter interaction is the focus of our paper. We show that it helps explain why individuals, particularly young investors and entrepreneurs, have larger than expected holdings of safe financial assets. In the financial planning literature, young investors are advised to hold a larger share of risky assets in their financial portfolios in order to capture the superior expected return of these assets. As investors grow older, they are advised to gradually reduce their holdings of risky assets. Jagannathan and Kocherlakota (1996) show that this advice is economically sound as long as the investor's human wealth is relatively uncorrelated with stock returns. |
