Hedging Permanent Income Shocks

This paper robustly connects observed portfolio choices to correlations of individual income shocks with an aggregate shock (or, equivalently, with stock market returns). The share of nonparticipating individuals displaying a positive correlation, and therefore a negative hedging demand for stocks, is above 79% in both our samples. Furthermore, correlations predict nonparticipation to the equity market, also out-of-sample and for the same individual over time. These results support the traditional hedging motive explanation for nonparticipation. Such new insight owes to the income shocks comovements across individuals, which we model and exploit to identify correlations. This paper was accepted by Lukas Schmid, finance. Funding: This work was supported by Inquire Europe, Observatoire de l’Epargne Européenne (OEE), and The Italian Ministry of Education, University and Research (MIUR) Department of Excellence Award for years 2018–2022 and 2023–2027. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.06893 .