The Determinants of Household Consumption and Their Relation with the Equity Risk Premium
This paper attempts to directly measure labor income risk diversification by observing the relation between the risk aversion implied by individual consumption and the stock market risk premium with a unique data set covering individual households in Japan. This is achieved by first showing that the correlation between the total consumption levels of individuals and the fraction of equity wealth held in proportion to total savings (as a proxy for liquid assets) has a relatively consistent relation. The sensitivity of total consumption with respect to equity holding as a fraction of total savings increases as the proportion of equity holding with respect to total savings increases. When the risk aversions implied by total consumption of households with different occupations (i.e. government workers and individual proprietors) are compared, the response to changes in the risk premium appear to affect the total consumption patterns of households differently depending on their labor income risk. Empirical results indicate that the risk aversion of the two types of households possess a statistically significant difference after running a pooled regression. This finding indirectly supports the luxury hypothesis proposed by Ait Sahalia et al. (2004) and the observation by Attanasio et al. (2002) that stock holders likely possess lower risk aversion levels; it also reveals the relations between individual consumption, the fraction of equity holding relative to total savings and the stock market risk premium. In addition, the total consumption changes are confirmed to be more sensitive to normalized wealth shocks generated from changes in the equity risk premium for individual proprietors as opposed to government workers. This supports the argument that the risk aversion of government workers is higher.