Risk Preference of Households in China : An Empirical Investigation

The shape and magnitude of risk preference of China households have rarely been explored due to lack of detailed data on China households’ investment behavior. Using panel data from China Household Finance Survey (CHFS) 2011 and 2013, we intent to investigate the hypothesis of harmonic absolute risk aversion (HARA), and to recover the magnitude of relative risk aversion from households’ portfolio choice. We find that households’ expenditure on risky asset is a linear function of total financial wealth, supporting HARA assumption. Further analysis reveals that among HARA class, constant relative risk aversion (CRRA) is favored against difference habit model, since risky asset share out of total wealth is almost independent of wealth level. The recovered relative risk aversion is quite heterogeneous across households, and its average magnitude is around 4.5, higher than the value postulated in macro and finance literature. However, we show that such magnitude is still not high enough to explain the equity premium from China stock market in a standard perfect market model as in Mehra and Prescott (1985)