Heterogeneous background risks and portfolio choice : Evidence from micro-level data

We construct a set of household-level background risk variables to capture the covariance structure of three nonfinancial assets and two financial assets. These risks are in general statistically significant and economically important for a household's stock market participation and stockholdings. A one-standard-deviation increase in background risks reduces the participation probability by 11% and the stockholdings-to-wealth ratio by 4%. The volatilities of labor income, housing value, and business income reduce a household's participation and stockholdings. A household with labor income highly correlated with stock (bond) returns is less (more) likely to invest in stock.