Estimating background risk hedging demands from cross‐sectional data

Abstract

Based on a theory of portfolio choice with non‐tradable assets, we estimate hedging demands due to background risks before and after the Great Recession for U.S households. Hedging demands related to human capital, residential property and business assets reduce financial risk‐taking, but these effects decline over the Great Recession, as does expected risk‐adjusted stock market performance. We also estimate the appropriate discount rate to compute the risk‐adjusted value of human capital, which declines by around eight percent over the period. Unlike previous literature requiring panel data with large time dimensions, our approach only requires cross‐sectional data to identify hedging demands.