The Impact of Wealth

Apr. 07, 2014

Peter Englund and his co-authors (Thomas Jansson, Sveriges Riksbank, and Todd Sinai, Wharton School) in a preliminary paper “How Parents Influence the Wealth Accumulation of their Children” study how net worth is correlated across generations.

They find that nearly all of the intergenerational wealth accumulation correlation is due to just two components of wealth growth: earnings and changes in house values. Other components, such as bequests and investment returns, have some impact but it is economically small. Interestingly, half of the intergenerational wealth influence reflects similarities in characteristics of parents and children rather than an independent role for wealth. Overall, the results are consistent with most of the correlation in wealth accumulation coming from parent/child similarity rather than parents providing an initial “leg up” for their children.

Since risk aversion, upbringing, genetic predispositions and many other individual characteristics are typically unobservable, the direct effect of household wealth on investment decisions is inherently difficult to estimate. For example, richer households might take more financial risk in their portfolio not because they are richer but simply because they are less risk averse and, as a result, have become richer by taking riskier occupations earlier in life. Paolo Sodini and his co-author (Laurent Calvet, HEC-Paris) in the published paper “Twin Picks: Disentangling the Determinants of Risk Taking in Household Portfolios” compare the financial portfolios owned by twin siblings allowing them to control for unobservable characteristics common in twin pairs. The explanatory power for their results can be as large as four times larger and reaches almost 50% for identical twins that communicate often. They find that wealth has a strong positive direct effect on financial risk taking and thus argue that households exhibit decreasing relative risk aversion. They also investigate the nature of household preferences, and conclude that they are consistent with theories of habit formation and consumption commitments.