Portfolio Allocation and Borrowing Constraints

Raslan Alzuabi (), Sarah Brown (), Daniel Gray (), Mark Harris and Christopher Spencer
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Raslan Alzuabi: Department of Economics, University of Sheffield, UK
Daniel Gray: Department of Economics, University of Sheffield, UK

No 2021009, Working Papers from The University of Sheffield, Department of Economics

Abstract: We explore the empirical relationship between borrowing constraints and household financial portfolio allocation. To motivate our analysis we develop a mean-variance model of portfolio allocation with three tradable asset classes defined by increasing risk, and establish a link between borrowing restrictions and financial portfolio allo- cation at the household level. Under non-restrictive assumptions the proportion of wealth allocated to the medium-risk asset is ambiguous. We also demonstrate that in the presence of both correlated background risk and borrowing constraints the domain of the non-binding risk-return space will be a function of background risk. We then analyse the US Survey of Consumer Finances with a view to empirically exploring the predictions of our theoretical framework. The distribution of medium-risk assets in US households is remarkably similar to that for high-risk assets, and suggests the presence of a more general ‘risk puzzle’, which our proxies for borrowing constraints partially explain. Our findings indicate that such constraints are inversely related to the proportion of financial wealth allocated to both high-risk and medium-risk assets, but are positively related to low-risk asset holdings. In light of our findings, further work aimed at accounting for the allocation of medium-risk assets in US households is considered expedient.

Keywords: Asset Allocation; Borrowing Constraints; Fractional Models (search for similar items in EconPapers)
JEL-codes: C35 D11 D14 G11 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2021-12
New Economics Papers: this item is included in nep-cwa and nep-rmg
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https://www.sheffield.ac.uk/economics/research/serps First version, December 2021 (application/pdf)

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Journal Article: Portfolio allocation and borrowing constraints (2024)
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