Portfolio Choice in the Presence of Personal Illiquid Projects

Miquel Faig and Pauline Shum

Working Papers from University of Toronto, Department of Economics

Abstract: Personal projects, such as a private business or the purchase of a home, influence portfolio choice in two ways. First, financial assets can be used to provide diversification against bad outcomes of personal projects. Second, financial assets can be used to provide liquidity to personal projects when these projects are illiquid and individuals have a limited debt capacity. The latter interaction is the focus of our paper. Due to this liquidity consideration, individuals are more risk averse if there is a large penalty for discontinuing or under-investing in the final stages of a project. A large penalty arises when there is strong complementarity between investments at dierent stages, or in projects that require lumpy investments. We provide a theoretical analysis and an empirical investigation of these eects. Using data from the 1995 Survey of Consumer Finances, we show that, consistent with our hypotheses, households which are saving to invest in their own businesses or in their own homes have significantly safer financial portfolios. The impact of the first category is particularly strong. Our findings also help explain why households, in particular younger ones, have larger than expected holdings of safe financial assets.

Keywords: Illiquid projects; portfolio choice (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2000-05-11
New Economics Papers: this item is included in nep-dge and nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Journal Article: Portfolio Choice in the Presence of Personal Illiquid Projects (2002)
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Persistent link: https://EconPapers.repec.org/RePEc:tor:tecipa:faig-00-03

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