Health status of the middle-aged and elderly and household asset allocation: portfolio choice with liquid and illiquid assets

ZHOU Huijun SHEN Ji GONG Liutang

【Abstract】Health risk is one of the most important background risks and may exert a significantly influence on an individual’s wealth accumulation and well-being. The negative shock of disease brings about higher demand for liquidity and changes people’s attitude toward asset liquidity and their investment psychology. How does health status affect Chinese households’ portfolio choice regarding liquid and illiquid risky assets? What are the primary determinants of the observed patterns? This paper attempts to answer these questions within a unified framework. We built a continuous-time optimal consumption and portfolio choice model based on Merton’s seminal work in which both liquid and illiquid risky assets are available for trading and investors are exposed to health risks. Trading a liquid asset incurred no transaction costs, so its purchase and sell prices were exactly the same. However, there was a bid-ask spread for the illiquid asset, where the spread was proportional to the purchase price. Our analysis showed that a household should focus not only on the absolute value of its liquid and illiquid wealth, but also on their relative magnitude. When the wealth of the illiquid asset account was too high relative to the wealth of the liquid asset account, the household should increase its holdings in liquid assets and reduce its holdings in illiquid assets. Conversely, when illiquid asset holdings were too low relative to liquid asset holdings, the household should reduce liquid assets and increase illiquid assets. When the ratio was in a medium range, the household should not adjust its illiquid assets holdings. An investor is healthy at first but over time will become irreversibly unhealthy. An unhealthy investor receives less labor income, but his healthcare expenditure increases, which should be drawn from liquid asset account. Worsening health also shortens an investor’s planning horizon. These two forces led to the following two testable implications: on the one hand, a change in health status exerts a large impact on the household’s holdings of illiquid assets; on the other hand, its impact on the household’s holdings of liquid assets is ambiguous. We used survey data from the China Health and Retirement Longitudinal Study (CHARLS) 2011–2015 to test the model’s implications. Our empirical evidence confirmed that households with bad health status tend to choose significantly lower holdings in housing investment than those with good health status. Our exploration revealed that this effect is mediated by a precautionary saving motive and the expectation of a shortened life span consistent with the model. When the explanatory variable was replaced by the holding of liquid risky assets, the result still held but exhibited much weaker significance and robustness. Finally, we conducted some robustness checks. We used the variable whether an individual has suffered from an accident or other unexpected, severe injury as an instrumental variable to solve the endogeneity problem. We also found that the policy intervention of home buying restrictions in a subset of cities does not affect our main results. The paper provides several policy implications. According to modern finance theory, in a complete market with sufficient financial tools, health risk as a typical idiosyncratic (negative) shock could be diversified to a large degree such that its impact on an individual’s consumption and asset allocation will be limited. However, our findings are far from this ideal outcome. The fundamental approach to eradicate poverty caused by illness is to improve the public health system and promote investment in social health. Further development of the financial market also matters; for example, the design of well-priced insurance products with stable yields that meet households’ needs merits further research. In addition, financial intermediaries should collaborate with medical institutions to provide loans to suffering households using housing as collateral. Finally, the development of the digital economy and “Internet+technology” will facilitate the organization of social resources to help families in need via crowd-funding platforms.

【Keywords】 household finance; health status; portfolio choice; asset liquidity;


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Vol 55, No. 10, Pages 193-208

October 2020


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