Households engage in precautionary saving to hedge against unexpected future income and expenditure shocks. Households' ability to have enough resources to protect themselves against these background risks and meet emergency needs can have important effects on their financial risk-taking capacities. Utilizing responses to a uniquely designed question and the wealth data obtained from the Survey of Consumer Finance, we construct a novel saving adequacy ratio that measures the extent to which households' saving can cover their future expenditure shocks and explore its implication for household financial risk-taking behaviors. The results show that households' ability to meet their emergency needs, as measured by the saving adequacy ratio, has significant explanatory power for households' stock market participation decisions and risky asset allocation decisions. We find that households with a higher level of available savings relative to their emergency expenditure needs have a higher probability of participating in stock markets, and the share of their financial wealth invested in risky assets is also higher. In addition, we find the impact of the adequacy ratio is larger for investments in households' non-retirement account, and for households who are more risk-averse or retired.
Li Sun (Fri,) studied this question.