Income Inequality and Household Default Risk in China: Measurement and Empirical Evidence

Rising income inequality and household debt burdens increasingly threaten financial stability in emerging markets. Yet how income inequality affects household default risk remains underexplored, and existing measures of default risk often neglect asset returns, volatility, and portfolio composition. Using data from the CHFS, we apply the Merton model to estimate household default risk based on household asset allocation, returns, and volatility. The results show that household default risk ranged from approximately 3% to 5% between 2015 and 2019. Income inequality significantly increases household default risk. Mechanism analyses show that income inequality raises default risk by tightening credit constraints, increasing asset portfolio risk, and deepening social fragmentation. Heterogeneity analyses indicate that the effect is more pronounced among rural, low-income, and middle-aged households, as well as male-headed households. Further analysis suggests that digital financial inclusion can serve as an effective tool for mitigating the risk-enhancing effect of income inequality.