Beruflich Dokumente
Kultur Dokumente
DISSERTATION
By
*****
Well-being of the baby boomer generation has been a concern for decades,
concentrated on old baby boomers, motivating the current study to model well-being of
young baby boomers in economic, physical, and psychological dimensions, where the
The data used for this study were from the 1979, 1980, 1981, 1993, 2000, 2002,
2004, and 2006 waves of the National Longitudinal Survey of Youth 1979. Well-being in
each dimension, investment in risky financial assets, and investment in education are
which was an indicator of education investment was predicted by one’s risk tolerance and
a set of preference characteristics. Objective risk tolerance under the drug use and sales
domain was found to have a significantly negative impact on years of schooling, which
means less risk tolerant persons invest more in themselves via education. Consistently,
females, Hispanics, and Blacks who were commonly considered less risk tolerant or more
economically disadvantaged were found to have more years of schooling. The findings
ii
provide evidence for the argument that investment in education may be viewed as one
type of insurance, rather than as risky investment, by the young baby boomer generation.
Young baby boomers who were not married or did not have any children also had more
years of schooling, reflecting the fact that investment in education involves considerable
opportunity costs. Therefore, the young boomers who were comparatively short of time
tended to invest less in education. Notice that parental education and education of the
oldest sibling affected education attainment of the young baby boomers, implying a
lasting and extensive effect of education investment that spreads not only from generation
potential factors that explained any discrepancy in risky financial investments across the
young boomers. Empirical results supported the hypothesis that investment in education
is a significant predictor variable, which means the young baby boomers who have more
schooling allocate their money in the financial market in the form of holding more stocks
or possessing a higher ratio of risky financial assets to financial assets, including stocks,
corporate bonds or government securities, and mutual funds. Economic indicators such as
net worth and total family income had a positive effect, regardless of the definitions of
risky financial investments, which implies risky financial assets are normal goods. Home
ownership was also a significant predictor for both risky financial investment measures,
minimize the risk from any investment. Objective measures and survey-based measures
iii
The last equation in the simultaneous equations model was to examine the
Total family income partially explained the disparity in psychological well-being. Note
Based on the empirical results, theoretical and policy implications were drawn.
These findings suggest that the original Capital Asset Pricing Model partially explained
demand for risky financial assets. Deviations from the model emphasize the importance
of adding human capital and other types of assets to the explanation of demand for risky
financial assets. The current study has several implications for practitioner, policy makers,
and researchers. These implications pertain to allocation time and money on investments
their time-varying, conditional risk tolerance, instant transfer and tax policies for
tolerance of individuals.
iv
Dedicated to my parents, husband, and sisters
v
ACKNOWLEDGMENTS
I wish to thank my advisor, Dr. Gong-Soog Hong, for her support and guidance
during my graduate studies in the Ohio State University. Her encouragement and
enthusiasm made this dissertation possible. Her mentorship and friendship also helped me
endure difficult times in both academic and personal life. I would like to thank Dr.
Kathryn Stafford for her continuous help and priceless comments throughout the process
of writing my dissertation. The experience of doing research with her inspired me as well
writing skills.
I am grateful to Dr. Robert Scharff for his valuable advice in the completion of
this dissertation. I also appreciate the experience of doing research with him. He provided
me with invaluable sights that directed and challenged my thought. I owe gratitude to Dr.
Sherman Hanna, who opened my research eyes and piloted me on the research road. I
deeply treasure every opportunity that he has offered me. His consideration of the
I also wish to thank those who helped me during the process of writing this
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I am truly grateful to my loving parents for believing in me and for providing me
support and understanding. I am also thankful to my sisters, Ssu-Wan and Hong-Ning, for
for his love and support. I deeply appreciate his patience and understanding of my work,
his company to endure difficult times of my life, and his support to pursue my goal.
Without their love and support, I could have never achieved this goal.
vii
VITA
PUBLICATIONS
Research Publication
1. Fang, M. C., & Hanna, S. D. (2008). Racial/ethnic differences in the risk aversion
measure of the 2004 Health and Retirement Study. Consumer Interests Annual, 54.
3. Cho, S. H., Fang, M. C., & Hanna, S. D. (2007). Who has emergency saving
viii
4. Fang, M. C. (June 2007). Obesity and financial decision making. Poster session,
tolerance in the 2004 Health and Retirement Study. Proceedings of the 2007 meeting of
7. Fang, M. C., & Peng, T. M. (Nov 2006). The impact of insurance coverage on
demand for health care. Poster session, Proceedings of the Gerontological Society of
8. Peng, T. M., & Fang, M. C. (Nov 2006). Economics of aging: Labor force
FIELDS OF STUDY
ix
TABLE OF CONTENTS
Page
Abstract .............................................................................................................................. ii
Dedication .......................................................................................................................... v
Acknowledgments ............................................................................................................. vi
Vita .................................................................................................................................. viii
List of Tables .................................................................................................................. xiv
List of Figures .................................................................................................................. xv
Chapters:
1. Introduction ................................................................................................................. 1
1.1 Background ........................................................................................................... 1
1.1.1 Definitions of risk .................................................................................... 3
1.1.2 Risk-taking behavior ................................................................................ 5
1.1.3 Baby boomer generation in the U.S ....................................................... 10
1.2 Problem statement ............................................................................................... 12
1.3 Purpose of the study ............................................................................................ 15
1.4 Significance of the study ..................................................................................... 16
1.5 Outline of the study ............................................................................................. 17
2. Review of literature ................................................................................................... 18
2.1 Risk tolerance ...................................................................................................... 18
2.1.1 Definitions of risk tolerance and risk aversion ...................................... 19
2.1.2 Measures of risk tolerance ..................................................................... 20
2.2 Determinants of investment in risky financial assets .......................................... 28
x
2.2.1 Effects of risk tolerance on investment in risky financial assets ........... 28
2.2.2 Effects of financial characteristics on investment in risky financial
assets ...................................................................................................... 29
2.2.3 Effects of demographic characteristics on investment in risky financial
assets ...................................................................................................... 31
2.3 Determinants of investment in education ........................................................... 35
2.3.1 Effects of risk tolerance on investment in education ............................. 35
2.3.2 Effect of personal characteristics on investment in education ............... 36
2.3.3 Effect of family background on investment in education ...................... 38
2.4 Individual well-being .......................................................................................... 40
2.4.1 Measures of well-being .......................................................................... 40
2.4.2 Determinants of well-being .................................................................... 48
2.5 Risk tolerance, risk-taking behavior, and individual well-being ........................ 50
3. Theoretical framework .............................................................................................. 52
3.1 Expected utility model ........................................................................................ 52
3.1.1 Description of expected utility model .................................................... 53
3.1.2 Measures of risk aversion from expected utility model ......................... 56
3.2 Capital asset pricing model ................................................................................. 58
3.2.1 Basic assumptions of CAPM ................................................................. 58
3.2.2 Equilibrium conditions under CAPM .................................................... 59
3.3 Specifications of theoretical model ..................................................................... 63
3.4 Hypotheses development .................................................................................... 65
3.4.1 Part one: determinants of investment in education ................................ 66
3.4.2 Part two: determinants of investment in risky financial assets .............. 67
3.4.3 Part three: determinants of Individual well-being ................................. 70
4. Data and methodology .............................................................................................. 72
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4.1 Data ..................................................................................................................... 72
4.2 Sample design ..................................................................................................... 75
4.3 Sample selection ................................................................................................. 76
4.4 Empirical method ................................................................................................ 79
4.4.1 Simultaneous equations model .............................................................. 79
4.5 Measurement of variables ................................................................................... 82
4.5.1 Dependent variables ............................................................................... 82
4.5.2 Independent variables ............................................................................ 91
4.6 Description of the Sample ................................................................................... 97
5. Results and discussion ............................................................................................ 109
5.1 Investment in education and investment in risky financial assets .................... 109
5.1.1 Multivariate Results for Model I .......................................................... 113
5.1.2 Multivariate Results for Model II ........................................................ 121
5.2 Well-being in economic, physical, and psychological dimension-in terms of
ratio of risky financial assets to financial assets .............................................. 124
5.2.1 Current earned income ......................................................................... 124
5.2.2 Family income ..................................................................................... 129
5.2.3 Physical Component Summary score .................................................. 131
5.2.4 Self-esteem ........................................................................................... 133
5.2.5 Mental Component Summary score ..................................................... 135
5.3 Well-being in economic, physical, and psychological dimension-in terms of
log of dollar amount of stocks .......................................................................... 137
5.3.1 Current earned income ......................................................................... 138
5.3.2 Family income ..................................................................................... 143
5.3.3 Physical Component Summary score .................................................. 144
5.3.4 Self-esteem ........................................................................................... 145
xii
5.3.5 Mental Component Summary score ..................................................... 146
5.4 Summary of Empirical Results ......................................................................... 147
6. Conclusions and implications ................................................................................. 152
6.1 Conclusions ....................................................................................................... 152
6.2 Implications ....................................................................................................... 157
6.2.1 Theoretical implications ....................................................................... 157
6.2.2 Implications for policymakers ............................................................. 159
6.2.3 Implications for research ...................................................................... 165
Appendices
xiii
LIST OF TABLES
Table Page
2.1 Measurements of risk tolerance in previous studies using the NLSY79 ................ 27
xiv
LIST OF FIGURES
Figure Page
xv
CHAPTER 1
INTRODUCTION
1.1 Background
The estimated number of baby boomers was 78.2 million, standing for roughly
26% of the U.S. population in 2005 and 45% of whole working age adults based on
estimated population in 2000 (U.S. Census Bureau, 2007). Important financial issues
about baby boomers range from the ability to deal with current financial status to
retirement well-being (Baek & DeVaney, 2004) which may have a profound impact on
the U.S. economy and social security system as a whole. In view of the size and critical
baby boomers, particularly the younger cohort, to provide for a rainy day.
Investments in financial assets and human capital in the form of education are
both considered risky because individuals encounter a state of uncertainty where some of
the possibilities involve a potential loss or other undesirable outcome. Similar to financial
assets, investment in education gives investors the right to receive a stream of risky
dividend payments in the future (Saks & Shore, 2005), playing a critical role in evolution
1
(Christiansen, Joensen, & Nielsen, 2007). Education investment is also one of the largest
investments an individual makes in his/her life (Saks & Shore, 2005), with the value of
human capital assets being estimated to be three to four times the value of financial assets
(Becker, 1993). “While financial assets are concentrated in the portfolios of the few,
human capital assets are held by all individuals, and even large changes in the market
value of financial assets are unlikely to affect the human capital investment decisions of
most individuals (Christiansen et al., 2007).” According to Williams (1978), the problems
of choosing a level of education and a financial portfolio are generally not separable.
Brown and Taylor (2005) also argued that individuals make investment decisions with
respect to both human capital and financial assets. Since most people tend to invest in
human capital in the form of education when young (Bryant & Zick, 2006), it is
necessary to take into consideration the potential role of investment in education when
determining financial asset allocation (Sahm, 2007; Guiso & Paiella, 2004) and human
capital accumulation (Brown, Ortiz, & Taylor, 2006; Hanna, Gutter, & Fan, 2001; Shaw,
1996). Individuals who have distinct risk tolerance act differently in terms of making
various investment decisions (Guiso & Paiella, 2004; Shaw, 1996) or possessing
portfolios with distinct levels of risk (McInish, Ramaswami, & Srivastava, 1993). For this
reason, to investigate the role of risk tolerance in jointly determining risky financial
2
Generally, a more risk tolerant investor who invests more in risky financial assets
and/or in education expects to earn higher returns to accumulate their wealth, increase
This chapter is organized as follows. The first section briefly describes the
definitions of risk and risk-taking behavior and delineates the baby boomer generation in
the U.S. The second and third sections lay out the problem statement and purpose of the
study. Last, significances and policy implications of the study are discussed.
Individuals bear risks in all aspects of their lives because the outcome of a
decision can only be known in the future (Taylor, 1974) and there is a tendency that
actual results are different from what is expected (Magee & Bickelhaupt, 1964). Scholars
have disputed over the meanings of risk and uncertainty (Chavas, 2004). One school of
thought claims that risk and uncertainty are not equivalent, meaning that risk corresponds
to events that can be associated with given probabilities while uncertainty corresponds to
events for which probability assessments are not possible. It is indeed a challenge to
distinguish risk from uncertainty in reality due to unclear consensus about the existence
and interpretation of a probability. The other school of thought accordingly agrees that
risk and uncertainty are equal in meanings (Athearn, 1971) and that the term “risk” can
3
Lopes, 1983; Taylor, 1974). In other words, risk exists whenever the outcomes of an
action are not assured (Yates & Stone, 1992) and risk is “measurable uncertainty (Knight,
1921)” or “effectively is uncertainty (Yates & Stone, 1992).” The current study is in line
Definitions of risk are available in extant literature. Markowitz (1952) argued that
variance could be regarded as risk, which is the first type of mathematical definition of
risk for portfolio selection. Semi-variance and probability of an adverse outcome are the
scholars related risk to possibility of loss. In Denenberg, Eilers, Hoffman, Kline, Melone,
and Snider (1974), risk was “uncertainty of loss.” Greene (1962) defined risk as the
uncertainty regarding loss or undesirable outcome, with the possibility of loss being the
common theme (Rable, 1968). Potential loss here does not merely refer to an outcome
that will make individuals worse off compared to some reference status quo position. An
outcome that is not as good as some other outcomes that might have been obtained is
regarded as loss (MacCrimmon & Wehrung, 1986). It is possible that the second form of
loss, namely opportunity loss, can sometimes turn risk-free situations into risky ones
when unexpected events occur; thus, it is unwise to exclude opportunity loss when
To summarize, risk is “any situation where some events are not known with
certainty (Chavas, 2004)”, with an emphasis on three fundamental factors (Sitkin & Pablo,
1992). First of all, risk is associated with outcome uncertainty such as the variability of
4
outcomes (Libby & Fishburn, 1977), absence of knowledge of the distribution of
potential outcomes (March, 1978), and disability to control over outcome attainment
(Vlek & Stallen, 1980). Second, risk can be applied to either positive or negative
outcomes because it is constituted based on the degree to which the expected outcomes
would be disappointing to a decision maker, rather than on the expected outcome itself
(Sitkin & Pablo, 1992). The existence of a gap between aspiration levels and the mean of
1987; March & Shapira, 1987). Last, decision makers should perceive the potential
may be characterized by the degree of risk associated with the decisions made (Sitkin &
Pablo, 1992). Decisions are considered riskier when expected outcomes are more
uncertain due to higher volatility, when it is more difficult to achieve decision goals, and
when the potential outcome set comprises some extreme consequence. Risk-taking is
essential to economic behavior (Moore, Evans, Brooks-Gunn, & Roth, 2001) because
individuals take greater risk or at least greater volatility in order to earn higher rates of
return (Hanna & Chen, 1997). This study models investment in risky financial assets,
investment decisions simultaneously is that financial and human capital assets are risky
5
and critical in portfolio choice (Becker & Becker, 1997; Schooley & Worden, 1996) and
Individuals hold financial assets in the form of generally risk-free assets, risky
assets, or both, with risky assets being an asset that provides an uncertain nominal cash
flow (Wang & Hanna, 1997). Individuals take more or less risks to acquire considerable
returns. In light of Morningstar (2007), the rate of return for long-term corporate bonds
was 3.2% with its standard deviation of 9.6% and the rate of return for large company
stocks was 9.1% with its standard deviation of 20.2%, in line with the observation that
people choose risky options only if these options offered higher expected returns
(Sokolowska & Pohorille, 2000) and with the finding that stocks should account for a
considerable proportion of portfolios for many households (Campbell & Viceira, 2002).
In addition to earning higher rates of returns, individuals may hold risky financial
assets due to the movement from defined benefit pension plans to defined contribution
pension plans such as Individual Retirement Accounts (IRAs) and 401(k) plans in recent
years (Hanna & Chen, 1997). In defined contribution pension plans, participants are
forced to make asset allocation decisions, to endure investment risks, and to enjoy the
rewards or carry the loss by themselves. Participants have a say in the amount they
choose to save. They, to a large degree, are also responsible for selecting the types of
securities that involve different levels of risks. Empirical evidence showed that defined
6
benefit plan participants were less likely while defined contribution plan participants
were more likely to participate in stock market (Curcuru, Heaton, & Lucas, 2007).
In terms of the 2001 Survey of Consumer Finances (SCF), for the average
household, 15.8% of total financial wealth was allocated on stocks, 7.6% on bonds,
24.4% on cash, 41.3% on housing, and 4.8% on other real estate (Curcuru et al., 2007). A
substantial proportion of financial wealth was held in retirement accounts, which means
account, accounting for 13.4% of the financial assets of the U.S. households. Defined
contribution plans have grown from 35% of the market in 1990 to roughly 45% in 2002,
with remaining share being attributable to annunities. The 2001 SCF data also revealed a
2007). “The extent to which risky asset holdings are diversified also varies greatly
(Curcuru et al., 2007).” Even if stock holdings as a percentage of wealth has increased
from 1989 to 2001 and participation rates in stock market increased in the 1990s, non-
participation rate remained high. The majority of households did not hold risky assets and
wealth as well as stock holdings were highly concentrated among the wealthy. The mean
and median values of ratio of risky assets to net wealth in 1989 were 6% and 1%,
respectively, and merely 25% of households had a value of 6% or higher (Wang & Hanna,
1997). Interestingly, people started buying stocks at a younger age than in the past,
implying a cohort effect that may explain trends in stock market participation. Moreover,
changes in risk tolerance or expected returns, reductions in background risk, and a fall in
7
Investment in Education
Human capital in the form of education is deemed an asset (Moore et al., 2001)
and investment in education is considered a risky one (Brown & Taylor, 2006; Schooley
& Worden, 1996; Becker, 1993). Rational persons invest in education only if the
expected rate of return were greater than the sum of the interest rate on relatively risk-
free assets and the liquidity and risk premiums associated with the investment (Becker,
1975). The reason to include positive liquidity premiums is that human capital assets in
the form of education are assets with less liquidity because they cannot be sold or served
as a collateral for a loan while physical assets such as housing can be used as a pledge for
a mortgage. Risk premiums are included due to the existence of substantial uncertainty.
For example, college students who are relatively young do not save enough for a down
payment, resulting in borrowing more money and consequently paying more interests
with unknown interest rate in the future. Students may face a risk of failure if they find
educational programs more difficult than expected (Guiso & Paiella, 2004) or discover
the lack of the necessary ability or the quality of schooling (Guiso & Paiella, 2004),
particularly since it is young people who do most of the investing. Investors are unsure
about the length of their life, the market value of the degree at time of completion (Guiso
& Paiella, 2004), the return on education investment (Kodde, 1986), and the timing of
job-offerings after one finishes the desired level of education (Kodde, 1986). Moreover,
the return to a person at a given age and with certain ability is uncertain due to other
unpredictable events (Levhari & Weiss, 1974). Risks with respect to investment in
education may vary across occupations and industries (Schooley & Worden, 1996).
8
Diversification used to reduce financial risks is not often available to reduce the degree of
Future earnings uncertainty is one of the most important reasons that education
investment is risky (Belzil & Leonardi, 2007). The UK Labour Force Survey showed that
the estimated return on schooling was about 4% for males, with an estimated dispersion
of 4%. For females, the mean return was 7% with a dispersion of 3.3%. The figures were
in line with those in studies that used the U.S. samples. Koop and Tobias (2002) found a
mean return of 12% with a deviation of 7% using the National Longitudinal Survey of
Youth 1979. Even if the mean return on education remained constant, the variance of
returns has been found to change over time (Harmon, Hogan, & Walker, 2003).
According to the U.S. Census Bureau (2006), roughly 27% of the U.S. population
three years old and over was enrolled in school in 2006. Among students in school,
around 23% were enrolled in college, graduate school or professional school, exclusive of
those who took private lessons. In terms of school expenditure, US devoted 7.6% of its
gross domestic product to schools and schooling in the 2003-04 school year, with $317
billion going to colleges and universities (U.S. Department of Education, 2007). Note that
the figures did not even include potential income students chose not to earn due to the
expensive. In addition to tuition and fees, the expenditures on room, board, and travel are
substantial and the forgone earnings are sizable. The costs of going to college are even a
heavier burden if one chooses to go to private colleges or universities (Becker & Becker,
1997). In the past, the cost of higher education was not a noticeable issue because merely
9
children from wealthy families could go to college. To date, more than half of high
school graduates continued their education into college. Among the high school graduates
who went to college, roughly 20% were Blacks, Hispanics, and other minorities who
fees have almost doubled since 1980 (Becker & Becker, 1997).
between 1946 and 1964 (U.S. Census Bureau, 2007). The estimated number of baby
boomers was 78.2 million as of 2005, accounting for roughly 26% of the U.S. population.
The percentage of women among the baby boomers was slightly higher than that of men
in 2005. Roughly 9.1 million and 8.0 million were Blacks and Hispanics in 2004,
respectively. The member of this demographic group age from 44 to 62 in 2008, meaning
this demographic behemoth will start leaving the workforce in roughly three years with
Baby boomers are the foundation of the U.S. population, playing multiple critical
roles. First, boomers accounted for roughly 45% of the whole working age adults based
on 2000 estimated population, making significant contributions to the U.S. economy. The
terms of purchasing power in marketplace. Since people live longer because of medical
advancement and younger people seek better and longer education, boomers feel more
responsibilities for taking care of their elderly parents and raising young children,
10
struggling with all of the issues associated with being sandwiched between generations
and having difficulty managing their time and money. The responsibilities become even
heavier as their offspring start their own families. Notice that boomers have a higher
divorce rate than prior generations and that the percentage of boomers who never married
is significantly higher than prior generations, meaning that these boomers independently
take these responsibilities. Baby boomers themselves may stop accumulating monetary
and non-monetary wealth due to aging and retirement. Health depreciates with age,
making it inevitable that baby boomers must bear heavier financial load with respect to
increasing medical or health care expenditures. In virtue of the critical role baby boomers
play inside and outside of their families, their decision making under risk deserves more
attention. Conservative baby boomers possess more relatively risk-free assets and are less
likely to accumulate wealth in a short time period while boomers who invest in risky
financial assets accumulate wealth rapidly and lead an easy life. The U.S. Census Bureau
(2000) showed that the majority of boomers completed high school and 29% had a
Bachelor’s degree or more, making themselves the most educated generation with a clear
understanding that higher education level helps find a well-paid job and lead a fulfilling
lifestyle. Some boomers even returned to college for the purposes of prolonging
While the baby boomers share common historic events and life experiences, there
is dissimilarity in terms of age cohorts. In Zagorsky (1997) and Yamokoski and Keister
(2006), individuals born between 1957 and 1964 were defined as young baby boomers.
Compared to their older counterparts, young baby boomers had slightly higher estimated
11
spending power while they had lower annual average household income and lower annual
average spending (U.S. Census Bureau, 2000). The household size of young boomers was
larger than that of old boomers; however, young boomers had a smaller average number
of earners per household. Although the poverty rate for boomers as a whole has
significantly declined, young boomers had a higher percentage in poverty than old
boomers. Moreover, most young baby boomers accumulated their wealth slowly and
steadily in a more traditional way (Zagorsky, 1999). For example, young boomers
increased their net wealth by mere $2,394 annually and 13% of them even did not have
any wealth or were in debt in their 30’s. The portfolio allocation pattern of young
boomers also changed over time. As the young boomers aged, they held more liquid
assets, implying their willingness to convert more liquid assets into cash as they
behavior has been intensely studied in past decades, focusing on such determinants as
Following the proposition of Sitkin and Pablo (1992) that risky behavior of an individual
is consistent with his/her risk propensities based on a conceptual model, where risk
propensity was defined as the tendency of an individual either to take or to avoid risks,
risk tolerance was found to be a powerful predictor of a vast array of risky choices
(Spivey, 2007; Sahm, 2007; Kimball, Sahm, & Shapiro, 2005; Guiso & Paiella, 2004).
12
Unfortunately, the fact that willingness to bear risks is not normally observable (Guiso &
Paiella, 2004) prevents it from attracting significant attention from empirical studies
Among existing studies, much stress has laid on how risks are treated in
hypothetical choices while very little seems to be known about whether the elicited risk
responses to hypothetical choices connect with risk-taking behavior in the real world
(Wärneryd, 1996). Even if Kimball et al. (2005) emphasized the role of risk tolerance in
economic theory to explain risky behavior, few surveys attempt direct measures,
exclusive of the Survey of Consumer Finances (SCF), the Panel Study of Income
Dynamics (PSID), and the Health and Retirement Study (HRS). However, the SCF
financial risk question may not be a good proxy for true risk tolerance (Chen & Finke,
1996) and not necessarily express one’s pure preference (Hanna & Chen, 1997). The
PSID and the HRS ask a set of income risk questions to locate risk tolerance while the
PSID surveys a much smaller sample of wealthy households and the HRS merely studies
Americans over the age of 50. Apparently, an unequal weight has been placed on rich or
older adults, leaving young baby boomers an unknown about their risk preference.
Risky investment decisions in different domain may affect each other. Decisions
made in each life stage can relate to one another. Extensive attention, however, has been
paid to one particular risk-taking behavior with respect to risk tolerance. One current
exception is Dohmen, Falk, Huffman, Sunde, Schupp, and Wagner (2005), who adopted a
series of risk questions in the 2004 German Socioeconomic Panel and concluded that the
average willingness to take risk is different across domains, although risk parameters
13
across domains were associated with one another. Another exception is MacCrimmon
and Wehrung (1990), who found that managers had different levels of risk tolerance
when making decisions with respect to personal and company money and to financial and
recreational risks. Even though investments in risky financial assets and human capital
assets are associated with much risk and affect optimal portfolio formation, economists
(Brown, Garino, & Taylor, 2006) and the later has drawn relatively less attention in risk
literature (Shaw, 1996; Kodde, 1986). Only a few publications have discussed both
with risk-taking behavior and with economic well-being (e.g. Guiso & Paiella, 2004;
McInish et al., 1993). There are abundant publications on examining the relationship
between risk-taking behavior and individual well-being. Unfortunately, little effort has
been made to connect risk tolerance with both risk-taking behavior and individual well-
being. Even if McInish et al. argued that more risk-averse investors should hold less risky
portfolios, which would, in turn, result in lower level of wealth, risk-taking behavior is
not explicitly incorporated in their model. In line with Guiso and Paiella that risk-averse
individuals were significantly less wealthy than their less risk-averse counterparts, a
study on whether risk-taking behavior is the bridge that connects risk tolerance and well-
being is needed to fill the research void. Comprehensive measures of well-being are also
14
1.3 Purpose of the Study
Literally, young baby boomers bear responsibilities similar to old baby boomers
and are at the life stage of accumulating their wealth and health. The lack of empirical
evidence for a theoretical model of choices under risk with respect to risk tolerance for
young baby boomers motivates the research. The unique characteristics of the National
Longitudinal Survey of Youth 1979 makes it possible to track changes in risk tolerance of
young baby boomers by taking advantage of a set of former illegal activity participation
economic models for making risky financial investment decisions with respect to risk
This study first examines whether risk tolerance derived using different methods is a
candidate for predicting investment decisions on risky financial assets and education or
risk tolerance exerts its impact on risky financial investments via education investment.
The impacts of risky investment decisions on well-being in each dimension are then
picture for risky financial investment, comprising both its determinants and consequences.
piecemeal and disjointed view, the current study makes an effort to connect the pieces.
1. Does risk tolerance increase or decrease investment in human capital assets in the form
of education?
15
2. Does risk tolerance increase or decrease investment in risky financial assets?
3. Does investment in human capital assets in the form of education increase or decrease
4. Does investment in human capital assets in the form of education increase or decrease
individual well-being?
that individuals must make with respect to risk involved and individual well-being.
Theoretically, this study employs economic theories to model risky behavior of young
baby boomers in the financial market, to identify predictive powers of risk tolerance
derived from illegal activity participation and hypothetical income risk questions, and to
incorporate the potential impact of education investment decision. In turn, this study
individual well-being. Whether or not risk tolerance explains the discrepancy in risk-
taking behavior among young boomers is important for policy makers and has a
16
An important objective of this study is to examine whether risk tolerance
risk-taking behavior on well-being provides insights into the effects of risky investment
The current study begins with a review of literature on risk tolerance and risky
with risk tolerance and risk-taking behavior are discussed as well. A theoretical model of
Chapter 3. Data, methodology, and empirical specification of the theoretical model are
are also presented in this chapter. Chapter 5 encompasses presentation and discussion of
empirical results. Conclusions and implications of this study are presented in Chapter 6.
17
CHAPTER 2
REVIEW OF LITERATURE
investments in risky financial assets and education, and individual well-being. The
chapter is organized in five sections. The first section reviews literature on definitions
and measures of risk tolerance. The second and the third sections review publications of
respective determinants. In the fourth section, measures of well-being and the association
of well-being with risk tolerance and with risk-taking behavior are reviewed. The last
section reviews existing literature on examining risk tolerance, risk-taking behavior, and
well-being jointly.
and Betz (2002) defined risk tolerance as “a person’s standing on the continuum from
risk aversion to risk seeking.” In Barsky, Juster, Kimball, and Shapiro (1997), risk
tolerance is the inverse of risk aversion, which was supported by other empirical studies
(e.g. Brown, Ortiz, et al., 2006; Faff, Mulino, & Chai, 2008). While risk aversion has
18
been commonly used in economic literature, risk tolerance is a financial planning concept
(Wang & Hanna, 1997) and it is the term that is mainly used by investment advisors
(Wang & Hanna, 2007). In the current study, risk tolerance and risk aversion are used
household financial decisions (Xiao, Alhabeeb, Hong, & Haynes, 2001) and affecting
one’s ability to achieve the desired financial goals (Wang & Hanna, 2007). Specifically,
financial risk tolerance plays a significant role in the difference in household portfolio
decision making (Hanna & Lindamood, 2004) and in the ownership of high-return assets
(Gutter & Fontes, 2006). One of the first definitions defined risk tolerance as willingness
of the goal being uncertain (Kogan & Wallach, 1964). Namely, financial risk tolerance is
1993) or maximum amount of volatility or uncertainty that one is willing to accept when
making financial decisions (Grable, 2000). Investor risk tolerance refers to maximum
amount and nature and by tastes or attitudes”, risk aversion is one type of risk attitudes
individuals may have when making risky choices. Individuals are said to be risk-averse as
19
they prefer a sure thing to an alternative with uncertain outcome (Highhouse & Yüce,
1996). Two common measures of risk aversion such as absolute risk aversion (ARA) and
relative risk aversion (RRA) were derived independently by Arrow (1965) and Pratt
(1964). ARA refers to one’s reaction to uncertainty regarding absolute dollar gains or
losses, measuring changes in dollar allocated to risky assets when wealth increases
1993)”, which indicates changes in portfolio to risky assets when wealth increases
Even if risk tolerance is elusive and ambiguous (Ekelund, Johansson, Järvelin, &
Lichtermann, 2005) and there are few, if any, generally recognized measures or
instruments to capture risk tolerance (Grable & Lytton, 1999b), Xiao et al. (2001)
recommended using attitudes toward risk and risky-taking behavior to measure risk
tolerance. Hanna et al. (2001) suggested estimating investment risk tolerance via
Subjective Measures
risk tolerance (Grable & Lytton, 1999b). One of the examples was from a financial diary
20
panel of upscale households. An index was created according to the ranks of the
“Consider only the following four investments and rank them in terms of your preference
for investing your next $5,000, from your most preferred (1) to least preferred (4). (1)
There is a slight chance (1 in 5) of some loss of principal, but the return is around 12
percent. (2) A speculative investment (3 in 5 chances of some loss of principal), but could
some loss of principal, but the return is around 16 percent. (4) The principal is assured
Grable and Lytton (1999b) suggested using subjective measures derived from
categorical responses without specifying the quantities to probe risk tolerance. For
instance, the SCF respondents choose one of the following categories that comes close to
the amount of financial risk that they are willing to take when saving or making
investments: (1) take substantial financial risks expecting to earn substantial return; (2)
take above average financial risks expecting to earn above average return; (3) take
average financial risks expecting to earn average return; and (4) not willing to take any
financial risks. Such a question as “how risk-tolerant are you” has its limitations on
probing risk tolerance. First, this measure does not necessarily reveal pure preferences
(Hanna & Chen, 1997), which means individuals who do not own any financial assets are
not in a position to take any risk while they may still choose category (1), (2), or (3).
Meanwhile, the question merely reflects a small part of the multi-dimension of risk. Note
21
that there is a big jump between categories (3) and (4), leaving category of “less-than-
average financial risks” absent in the options (Schooley & Worden, 1996). It is also likely
that people misstate their risk tolerance when answering questions (Grable & Lytton).
situations and scenarios in each specific domain. Mittra (1995), for example, presented
two questionnaires that relate to investor choices to measure risk tolerance. Grable and
Lytton (1999a) introduced a 20-item questionnaire, with higher score indicating more
Lytton (1999b) conducted a principal components factor analysis based on the original 20
items and argued that a 13-item summative scale is more brief, non-redundant, and
interesting to complete. The results based on the questionnaire showed that more than
half of respondents had moderate risk tolerance and 27% and 13% of them had low and
high risk tolerance, respectively, which were consistent with previous results.
A common concern is that subjective measures are not linked rigorously to the
concept of risk tolerance in economic theories; thus, they merely reflect a combination of
Objective Measures
Sung and Hanna (1996) suggested using objective measures due to the difficulty
of assessing risk tolerance. The level of risk aversion/risk tolerance can be estimated
22
1996) and ratio of risky assets to total wealth (Wang & Hanna, 1997), assuming that
more risk tolerant people own a greater amount of risky assets or a larger share of risky
assets. Risk aversion can also be inferred indirectly from singular behavioral consequence
such as an insurance purchase decision (Ekelund et al., 2005; Barsky et al., 1997).
was positively related to smoking and drinking (Barsky et al., 1997). In Hersch and
Viscusi (1990) and Hersch and Pickton (1995), non-smoking life style and seat-belt usage
were proxies for willingness to bear risk to explore wage-risk tradeoff, assuming that
non-smokers and seat-belt users reveal a high value of safety. Viscusi and Hersch (2001)
used cigarette smoking as a proxy for risk attitudes to predict the probability of smokers
Risk associated with drug dealing are so substantial that individuals who have
lower risk aversion are expected to be more likely to sell illegal drugs. For this reason,
Fairlie (2002) used being a drug dealer as a proxy for risk tolerance, entrepreneurial
ability, and a preference for autonomy. Results showed that former drug dealers were
more likely to be self-employed in later years than non-dealers after controlling for other
characteristics. Among drug dealers, those who sold drugs more frequently, who used
drugs less frequently, and who received income from drug selling as a youth were more
Instead of observing one particular behavior, Bellante and Link (1981) measured
innate risk aversion by creating an index based on behavior in different domains: the
condition and insurance of automobiles owned, seat-belt usage, medical coverage, and
23
smoking and drinking behavior. The hypothesis that the risk-averse are more likely to
seek employment in public sectors was supported using the PSID data. Similarly,
Feinberg (1977) created an index of risk avoidance using the same data set. The
following items are included: the conditions of cars, whether having insurance on cars,
seat-belt usage, whether having medical insurance, cigarette smoking, and savings
available. The hypothesis that more risk-averse individuals will have a shorter expected
Objective measures may not be perfect. Financial risk tolerance in terms of actual
asset holdings pose serious validity problems due to unrealistic assumptions that an
investor has full information and can make rational choices based on his/her situation and
risk tolerance without advice from a third party (Friend & Blume, 1975; Wang & Hanna,
1997), making the results more descriptive, rather than predictive (Grable & Lytton,
1999b). Actual behavior may “not match economic models because most households
have very low levels of liquid assets and therefore can not hold high levels of risky asset
(Hanna et al., 2001).” Objective measures also fail to account for multi-dimensional
nature of risk or to explain actual investment behavior. Investors may not fully
understand the meaning of risk when making decisions (Schooley & Worden, 1996) or
may have different expectations of returns (Sahm, 2007); thus, the proxies fail to capture
actual risk tolerance. The created index may reflect one’s ability to tolerate risk rather
than the propensity to tolerate it (Bellante & Link, 1981). It is also possible that investors
do not always invest in ways that match their true underlying risk tolerance. Individuals
may decide to sell illegal drugs due to reasons irrelevant to risk tolerance (Fairlie, 2002).
24
Hypothetical Questions
scenarios (Schooley & Worden, 1996). Generally, hypothetical questions should involve
questions should cover probability of gains and loss and dollar amount of potential gains
and loss because individuals make risky financial decisions based on all of these
components (MacCrimmon & Wehrung, 1986). One criticism for studies that used
hypothetical questions is that they recruited college students who are less likely to face
actual financial risk or convenient samples which may not be a nationally representative
representative surveys have recently incorporated these questions into the questionnaires.
The HRS data, for instance, has being asking a series of income risk questions to
construct measures of the Arrow-Pratt concept of risk aversion since 1992. Respondents
first chose between their current certain job and a new, risky job that provided them with
two uncertain outcomes of equal chances, either doubling lifetime income or cutting it by
a specific portion, so-called downside risk. The measure was refined via a sequence of
questions with different downside risks (Kimball et al., 2005). Aware of the potential for
a status quo bias due to question wording that makes individuals have an aversion to a
new job irrelevant to its income risk, the 1998 HRS revised the questions according to
Barsky et al. (1997) so that individuals made choices between two new jobs. Another
25
nationally representative survey, the National Longitudinal Survey of Youth 1979
(NLSY79), included hypothetical income risk questions with three different downside
risks in 1993. Generally, respondents are classified into two or four mutually exclusive
categories according to their responses to two of the three questions (See Table 2.1).
better proxy to predict future financial behavior due to practical and theoretical
considerations (Yao, Gutter, & Hanna, 2005). First of all, it is not possible to derive risk
tolerance through actual portfolio allocations for those who have no portfolio to allocate
while risk tolerance of those who do not possess any financial assets can be captured by
their responses to hypothetical questions (Yao, Hanna, & Lindamood, 2004). Individuals
may change their actual portfolio allocations due to factors unrelated to risk tolerance;
thus, “observations of how people deal with risks in real life have cast some doubts on
the preference of risk aversion (Wärneryd, 1996).” Additionally, risk tolerance derived
from hypothetical questions has been connected with the theoretical concept of RRA in
the expected utility model (Grable, 2008; Hanna et al., 2001). Note that this method also
has its limitations. Some respondents may answer questions without understanding the
meanings of the questions or value their job based on reasons other than a pecuniary one
and hesitate to leave it despite the large expected increase in income. It is possible that
26
Author (s) Measurements
Chen (2003) - Highly risk-averse (46%):
respondents who declined the best two offers
- Not highly risk-averse (54%):
all others that are not classified as highly risk-averse
Amuedo- - Risk-averse:
Dorantes & Pozo if respondent answered no to both of the first and the third offers
(2002) - Low risk loving:
if respondent answered no to the first offer and yes to the third one
- Moderate risk loving:
if respondent answered yes to the first offer and no to the second one
- High risk loving:
if a respondent answered yes to both the first and the second offers
Table 2.1 Measurements of Risk Tolerance in Previous Studies Using the NLSY79
27
2.2 Determinants of Investment in Risky Financial Assets
and allocation and concluded that variables such as the presence of non-diversifiable
costs are significant factors in explaining these differences (e.g. Curcuru et al., 2007).
The current study emphasizes the roles of risk tolerance and demographic and financial
Standard portfolio theory suggests that all the differences in observed portfolio
composition across individuals should reflect differences in risk preferences (Guiso &
Paiella, 2004), implying that the more risk-averse would prefer a safer portfolio given the
A wealth of study has extensively explored the relationship between risk tolerance
and asset allocation theoretically (Arrow, 1965; Pratt, 1964) and empirically (Siegel &
Hoban, 1982, 1991; Friend & Blume, 1975) using different data sets. First, using the
HRS data set, Sahm (2007) showed a significantly positive relationship between risk
tolerance and stocks holding and Hariharan, Chapman, and Domian (2000) argued that
risk-tolerant individuals were more likely to hold a larger proportion of risky assets. That
risk aversion is a predictor of actual risky choices was demonstrated by using the SCF
data (Wang & Hanna, 2007). In Schooley and Worden (1996), respondents who were not
willing to take any risk had the lowest mean ratio of risky assets to wealth. Compared to
28
those who were not willing to take any risk, respondents who were willing to take
substantial financial risk had higher ratio of risky asset to wealth, showing that RRA
measured by asset allocation was related to that captured by responses to the SCF
question. Gutter and Fontes (2006) concluded that respondents who were unwilling to
take any risk were less likely to hold risky assets compared to those who were willing to
take average financial risk. Respondents who were willing to take above average risk
were more likely to hold risky assets than those who were willing to take average risk.
Wang and Hanna (2007) found similar result to Gutter and Fontes’ while the difference in
stock holdings was not found between those who were willing to take substantial
financial risk and those who were willing to take above average financial risk. That there
was no steady increase in stock ownership as the level of financial risk tolerance
increases may attribute to the peculiarity of the SCF question. Results in terms of foreign
data were also in line with those using the US data (e.g. Guiso & Paiella, 2004; Arrondel
& Calvo-Pardo, 2002). Notice that Barsky et al. (1997) found a much weaker relationship
between risk tolerance and risky asset holding than theory suggested it should be.
(Gutter & Fontes, 2006; Barsky et al., 1997). Generally, net family income is included to
account for risk and portfolio choice differences among income strata assuming that
higher total income allows individuals to diversify their investments. Inherited wealth is
taken into account because “intergenerational transfers account for the vast majority of
29
aggregate U.S. capital formation (Kotlikoff & Summers, 1981).”
As what expected, income was positively related to the likelihood of owning risky
assets (Gutter & Fontes, 2006; Gutter, Fox, & Montalto, 1999). The level of portfolio
allocated to risky assets increased with income (Zhong & Xiao, 1995). Consistent results
can be found in Gutter et al. (1999). Specifically, income had a positive impact on stock
ownership until age 45 and the positive relationship became negative after age 45 (Wang
& Hanna, 2007). The difference in portfolio composition was also associated with net
worth (Gittleman & Wolff, 2004). In McInish et al. (1993) and Cohn, Lewellen, Lease,
and Schlarbaum (1975), wealthy investors held a larger proportion of risky assets.
Individuals who had higher net worth were more likely to invest in the stock market
(Gutter & Fontes, 2006; Hong, Kubik, & Stein, 2004; Xiao et al., 2001) or have a higher
level of risky asset ownership (Gutter & Fontes, 2006; Hong et al., 2004; Hariharan, et al.,
2000; Haliassos & Bertaut, 1995), consistent with Coleman’s (2003) finding that equity
In addition to income and net worth, other types of financial resources play
different roles in determining risky financial investments. In Gutter and Fontes (2006),
individuals who were eligible for an employer-sponsored retirement plan were less likely
to hold risky assets. Defined benefit plan participants were less likely while defined
contribution plan participants were more likely to participate in stock market (Curcuru et
al., 2007). In Schooley and Worden (1996), individuals who expected to have less
adequate retirement income or zero value of human capital were more likely to hold risky
assets. Home ownership had a positive impact on stock holding in Wang and Hanna
30
(2007); however, home ownership effect was negative in Xiao et al. (2001). Similarly,
Curcuru et al. (2007) found that the probability of stock ownership was negatively related
to home equity/net worth, home value, and mortgage scaled by total financial wealth.
Moreover, individuals who expected to have inheritance tended to have a higher level of
portfolio allocation to risky assets (Wang & Hanna, 1997). Those who desired to leave an
inheritance also had a higher ratio of risky assets to wealth (e.g. Hariharan et al., 2000;
Schooley & Worden, 1996; Siegel & Hoban, 1991). Last, households that had financial
assets exceeding one month’s income held more stocks (Wang & Hanna, 2007).
Households with three month income worth of liquid financial assets were more likely to
hold risky assets while they were less likely to have a higher level of risky asset
Assets
studies, however, did not demonstrate a consistent relationship between age and risky
asset holdings. In Curcuru et al. (2007), the probability of stock ownership was
negatively related to age. Coleman (2003) also found a negative relationship between age
and the level of portfolio allocation to risky assets. Contrary to these findings, Bertaut
(1998) and Zhong and Xiao (1995) found a positive relationship between age and the
probability of holding stocks. Specifically, McInish et al. (1993) indicated that investors
31
aged 45 to 54 held the highest proportion of risky assets. Those who aged under 45 held
the highest proportion of non-risky assets. In line with McInish et al., Guiso and Paiella
(2004) showed that older respondents were more likely to own risky assets and had a
larger share of risky assets. Non-linear relationship of age with risky financial investment
was found in literature. For instance, the ratio of risky assets to net worth and the
probability of stock ownership increased with age at a diminishing rate (e.g. Wang &
Hanna, 1997; Gutter et al., 1999). In Wang and Hanna (2007), there was a positive
relationship between age and stock ownership for those who aged 45 or younger and a
negative relationship for those who aged over 45. Kimball et al. (2005), however, found
Gender is associated with portfolio choices. Males generally had more aggressive
portfolios (e.g. Guiso & Paiella, 2004; Jianakoplos & Bernasek, 1998) or allocated higher
proportions of their portfolios to risky assets than females (Guiso & Paiella, 2004;
Coleman, 2003; Bernasek & Shwiff, 2001). Consistently, females were more likely to
hold relatively risk-free assets such as Treasury Bills (Hariharan et al., 2000).
In terms of race and ethnicity, Stevenson and Plath (2002) indicated that Blacks
were less likely to invest in risky assets. Sahm (2007) found that African Americans and
Hispanics were much less likely to own stocks than Whites. In other studies, including
Hong et al. (2004), Mabry (1999), and Loury (1998), Blacks invested less in the stock
Wang and Hanna (2007) that Whites were more likely to hold stocks and by Xiao et al.
(2001) that Whites were more likely to have a higher ratio of risky assets. Conversely,
32
Schooley and Worden (1996) argued that non-Whites had a higher ratio of risky assets to
wealth than Whites. Gutter and Fontes (2006) did not find a significant race effect on
portfolio allocation and Siegel and Hoban (1991) indicated that race was not a significant
determinant of risky asset holding when controlling for other variables. Note that race
may interact with other variables to affect the likelihood of holding risky assets (Gutter &
Fontes, 2006). For instance, presence of children in household increased the probability
of holding risky assets for both White and Black households, with being Blacks having a
larger effect. This finding was consistent with Gutter et al. (1999), who argued that
presence of children had a positive effect on holding risky assets merely for Blacks.
Marital status can affect investment in risky financial assets. Gutter and Fontes
(2006), for example, found that non-married households were less likely to hold risky
assets than married ones, implying the ability of sharing risk between husband and wife.
Similarly, Wang and Hanna (2007) showed that non-couple households were less likely
to have stocks compared to married households. Hariharan et al. (2000) presented that
married males were less likely to invest in relatively risk-free assets such as Treasury
Bills than their single female counterparts. On the contrary, Sahm (2007) found that
being married was associated with lower rate of stock ownership without controlling for
risk tolerance while the relationship was insignificant after controlling for risk tolerance.
The impact of household size was found to be inconsistent across previous works.
In Gutter and Fontes (2006), household size was negatively related to risky asset
ownership, implying the need for liquidity for current consumption. Jianakoplos and
33
sisters, nieces, nephews, and other young people who may be dependents in household,
indicated that the impact of household size on proportion of risky assets varied depending
on marital status and gender. As the number of young dependents in household increased,
single females held a smaller proportion of risky assets while married couples tended to
hold a larger proportion of risky assets. Presence of young dependents, however, did not
affect single males in determining proportion of risky assets. The insignificant effect of
Occupational choice and working status can influence one’s risky financial
investment. In Schooley and Worden (1996), full-time wage earners held a significantly
higher ratio of risky assets to wealth. Xiao et al. (2001) noted that business owning
households were more likely to have higher risky asset ratios than their non-owner
counterparts. Wang and Hanna (2007) showed that non-manager business owners were
more likely to possess stocks than manager owners and non-business owners after
controlling for other variables. Being unemployed had a negative effect on the probability
of holding risky assets, with being Black even having a larger negative effect (Gutter &
Fontes, 2006). Additionally, an older household whose head was retired or not in the
labor force had a relatively lower ratio of risky assets to wealth compared to those in their
other risky financial asset holdings in literature (e.g. Wang & Hanna, 2007; Sahm, 2007;
Gutter & Fontes, 2006; Kimball et al., 2005; Hong et al., 2004; Coleman, 2003; Gutter et
al., 1999), reflecting that education enables individuals to have more knowledge and
34
access to the financial market (Gutter & Fontes, 2006). Specifically, Guiso and Paiella
(2004) indicated that education attainment in terms of a high school diploma and a
university degree was positively associated with risky asset ownership and with a share
of risky assets. In Hariharan et al. (2000), the educated were more likely to allocate their
wealth to risky assets. Interestingly, individuals who had a professional degree or a Ph.D.
degree had a smaller percentage allocation of the defined contribution pension to stocks
than those with a B.A. or M.A. degree (Bernasek & Shwiff, 2001), which conflicts with
previous findings.
examine the role of risk tolerance in determining human capital accumulation (Brown,
Ortiz, et al., 2006). Unfortunately, while examinations into the relationship between risk
economics, the association of risk tolerance with human capital investment in the form of
education did not earn equivalent attention (Belzil & Leonardi, 2007). Among existing
literature, most research was more theoretical due to the difficulty in quantifying the
marginal risk of education, leaving empirical work rather scarce and inconclusive (Belzil
35
& Leonardi, 2007). Mainly, more risk tolerant individuals have greater education
attainment (Grable, 2000; Strube, 1991). Specifically, Shaw (1996) predicted an inverse
relationship between risk aversion and the level of education using the SCF data. Chen
(2003) found that risk aversion was negatively associated with college attendance using
the NLSY79 data. The effect of risk aversion was even stronger for non-African-
Americans and for those whose parents had lower education level. In Brown, Ortiz, et al.
(2006), education investment was positively related to risk tolerance and negatively
related to risk aversion. After controlling for other variables, Guiso and Paiella (2004)
indicated that the risk-averse invested less in education compared to their risk-loving and
risk aversion invested less in education than those with lower level of risk aversion.
Using Italian data, a moderate portion of the probability that one receives higher
education was explained by risk aversion after controlling for other variables (Belzil
&Leonardi, 2007). The impact of risk aversion on education investment was examined
indirectly by Brunello (2002), who used a sample of married Italian male household
heads to indicate that the selected years of schooling was negatively related to ARA and
that respondents with lower value of RISK were likely to have more years of schooling.
Young persons generally are inclined to overestimate their ability and the chance
of good fortune; thus, human capital investment that promises a higher return to a person
with ability and luck would be more attractive than a similar physical investment (Becker,
36
1975). In other words, younger persons had lower grade termination rates (Belzil &
Leonardi, 2007). Conversely, Guiso and Paiella (2004) found that older adults invested
more in education. Brown, Ortiz, et al. (2006) showed a non-linear relationship indicating
that age was positively and then negatively related to indices of years of completed
with and without controlling for risk aversion, showing that females invested more in
college education (Chen, 2003). Consistently, Belzil and Leonardi (2007) found that
females had lower grade termination rates. In Kodde (1986), males had a lower
finishing high school. The male-female difference in demand for education may be due to
taste effects or differences in risk aversion (Kodde, 1986). Note that Brown, Ortiz, et al.
(2006) inconsistently concluded that males were more likely to invest in education in
well. Chen (2003), for example, showed that African-Americans were more likely to
invest in college education. The model that included the interaction term between risk
aversion and race indicated that race moderated the negative effect of risk aversion on
college attendance, implying that college attendance was even riskier for non-African-
Personal ability affects one’s demand for education. Mainly, a more able person is
assumed to learn more than a less able person at a given level of educational expenditure,
37
resulting in a greater discrepancy in productivity, earnings, and rate of return. Following
the rationale, Kodde (1986) showed that scholastic abilities increased the probability of
demanding for additional education. The effect of ability score in mathematics even
Chen (2003), academic ability was associated with investment in college education
without controlling for risk aversion. Respondents who had higher academic ability were
the individuals. Individuals will have an opportunity to receive college education if their
parents are willing to supply them with a greater amount of financial backing or if their
parents went to college. The number and the gender of siblings and the birth order may
also affect the opportunity to receive education due to limited resources available. These
findings were generally consistent with Bowles (1972) that “the measures of family
demonstrate a positive association between initial stock of non-human wealth and human
capital accumulation in the form of education, implying that persons with more financial
resources invested more in themselves. Kodde’s (1986) empirical research also predicted
a positive effect of parental income measured by net monthly family earnings on the
38
(2001) suggested a positive effect of family income on college enrollment. In Chen
(2003), family income has little impact on deciding to go to college because there are
can explain education investment disparity. Brown, Ortiz, et al. (2006), for example,
found that respondents whose father’s occupational status was professional or managerial
and self-employed when they were growing up were more likely to invest in education.
Similarly, grade continuation was higher for those whose parents worked in a white collar
parents had more education had a higher probability of demanding for additional
education (Kodde, 1986). In Chen (2003), respondents whose parents had college
education were inclined to go to college. Taking into account the interaction effect of risk
aversion and parental education, parental education moderated the negative effect of risk
aversion on college attendance, implying that college attendance was even riskier for
those whose parents were less-educated. Guiso and Paiella (2004) showed a positive
effect of education level of the father of the household head on education investment of
the head. In Brown, Ortiz, et al. (2006), respondents whose father or mother had high
school and college education were more likely to invest in education. Put it in another
way, grade termination rate was lower for those whose parents received higher education
(Belzil & Leonardi, 2007). Interestingly, parental education was even more significant
than risk aversion in predicting schooling attainment. The potential reasons that risk
aversion does not play a substantially larger role are due to endogeneity of risk aversion
39
measure and measurement error. It is also because that the youth regard schooling as
insurance and that the marginal risk associated with higher education is small.
a respondent lived in the northeast, the west, and the south when young relate to the cost
of school attendance; therefore, in turn, explain the decision of college attendance (Chen,
2003; 2001). Using the Italian data, Belzil and Leonardi (2007) consistently indicated that
respondents living in the North of Italy which is the most economically developed region
in Italy obtained more schooling compared to their counterparts living in other areas.
Well-being refers to “peoples’ positive evaluations and feelings about their lives”
(Diener & Seligman, 2004) or “the state of health, comfort, or happiness that results from
(among other things) the consumption of goods and services (Magrabi, Chung, Cha, &
Yang, 1991)”, which is a central concern in the U.S. today. This section reviews
measures of well-being in different dimensions and factors that may contribute to explain
(Thornton, 2001). This study mainly outlines the first three well-being measures
40
Economic Well-Being
theory is a key component of overall well-being (Osberg & Sharpe, 2002); however,
(1999), for example, employed income, wealth, and poverty indices that provide basic
used employment, poverty, food affordability, and housing affordability. Thornton (2001)
focused on issues such as income, assets, employment, and living standard. Osberg and
Sharpe (2002) included consumption flows, stock accumulation, economic security, and
income distribution. In Park & DeVaney (2007), the authors summarized income, assets,
with choices can make decisions to maximize their well-being. According to Diener and
Seligman (2004), “because income correlates with number of choices, greater income is
equivalent to higher well-being”. In sum, income has been considered a primary indicator
of economic well-being (Park & DeVaney, 2007). Income is also a good proxy for
material welfare, providing valuable insights into financial stability of a household (Hong
& Swanson, 1995). Low-income households encounter difficulty meeting basic needs;
thus, have lower level of well-being. Particularly, current earned income is a personal-
level measure of well-being. Total family income that includes all forms of earned and
unearned income such as earnings, dividends, interests, rent, capital gains, gifts, social
security, and other transfer payments is a household-level measure (Mullis, 1992). In line
41
with life-cycle income hypothesis, Mullis created a life-time proxy by averaging the sum
of current income in terms of wages, salaries, dividends, interests, and transfer and
pension payments during a period of seven years. Wealth which is mainly measured by
net worth is a critical component of well-being, particularly during retirement (Keister &
Moller, 2000), representing potential consumption for the rest of an individual’s life (Lee
& Hanna, 1995) and economic security for individuals (Keister & Moller, 2000). Some
scholars suggested including human wealth as a part of total wealth (e.g. Lee & Hanna,
1995; Friend & Blume, 1975). Human wealth, the present value of non-investment
income, may be measured either by the value of labor income to the age at which a
respondent expects to retire and the values of social security income, pension income,
and transfer payments (Friend & Blume, 1975) or by the present value of future earnings
Note that income and net worth might not fully represent all of the components of
(Hong & Swanson, 1995), making the two indicators inadequate to measure well-being
(Mullis, 1992); complementary measures are needed. For this reason, Park and DeVaney
(2007) introduced asset and debt levels and suggested using two financial ratios which
are indicators of current financial strength and progress over time (Winger & Frasca,
2000) to integrate all of the major measures. First of all, the debt-to-income ratio reveals
the proportion of gross income used to repay consumer debt and represents the level of
debt a household can safely manage with respect to income, where debt is calculated by
summing up credit card debt, installment loans, and other debts, exclusive of mortgage
42
debt and home equity loans. According to DeVaney (2000) and Garman and Forgue
(2006), a debt-to-income ratio of less than 0.15 is recommended while Garman and
Forgue (1991) argued that a value of less than 0.3 indicates financial strength.
Aside from these widely-used measures, the U.S. Census Bureau administrated
questions on income adequacy, ability to meet basic needs, and food sufficiency to
portray one’s quality of life (Bauman, 1999). Mullis (1992) introduced poverty level
adequacy suggested by Hanna, Chang, Fan, and Bae (1993), Hong and Swanson (1995)
used emergency fund adequacy evaluated by dividing total liquid assets by two months
and annuitized net worth and dividing the summed value by poverty level income,
suggesting that economic well-being is associated with a variety of factors, rather than
Physical Well-Being
health such as weight, height, fitness, diseases, immunizations, substance use, and
physical abilities, limitations, problems, and conditions (Thornton, 2001). Generally, the
43
positive states of well-being correlate with better physical health (Diener & Seligman,
2004). Despite the subjective measure of health status, this measure is expected to be
correlated with medical assessment and with personal evaluation of well-being (Hartog &
Health refers to “a state of complete physical, mental and social well-being and
not merely the absence of disease or infirmity (World Health Organization, 1978)”; for
(Scholle, Whiteside, Kelleher, Bradley, & Casey, 1995) and several surveys of general
health, including the Quality of Well-Being Scale, the Sickness Impact Portfolio, the
Nottingham Health Portfolio, and the Medical Outcome Studies Short Form Health
measures in that it does not focus on any specific dimensions of health status but mainly
reflects physical health problems and partially covers mental health problems (Krause &
Jay, 1994). Since the single question summarizes a variety of components, it is one of the
most frequently-used measures in many major studies (Krause & Jay, 1994). National
surveys such as the National Health Interview Survey, the National Health and Nutrition
Examination, the Rand Health Insurance Experiment, and the Medical Outcomes Study
all employ this single question as a component part. One concern about this measure is
that the youth tend to answer the question based on their behavior while older adults tend
to answer it according to their health problems. The single item may lose some of the
44
precision when compared to longer forms of health status measures. Despite the
limitations, its predictive power is satisfactory. Miilunpalo, Vuori, Oja, Pasanen, and
Urponen (1997), for example, showed a strong relationship between self-reported health
status and the prevalence of chronic disease. There was also a linear relationship between
baseline health status and number of reported visits to physicians in the next year. Idler
and Angel (1990) indicated that self-reported health status was associated with mortality.
and happiness; Bradburn and Caplovitz (1965) assumed psychological well-being, mental
health, or happiness to be the same in meanings; Diener, Sapyta, and Suh (1998) argued
life. Specifically, mental health is more than the absence of mental illness but represents
health, goodness, appearance, and social competence (Goldsmith, Darity, & Veum,
1998)”; life satisfaction is the cognitive component of SWB (Pavot & Diener, 1993),
indicating a judgmental process in which individuals assess the quality of life in terms of
their own unique criteria (Shin & Johnson, 1978); happiness is the degree to which an
individual judges the overall quality of life as favorable (Veenhoven, 1993). Even if
happiness is not identical to utility, it captures life satisfaction and is considered a useful
45
approximation to utility (Frey & Stutzer, 2002). Economists have used SWB to measure
consumer preference and social welfare (Gruber & Mullainathan, 2005; Di Tella,
The measures of SWB can be elicited by asking respondents about their happiness
and life satisfaction as a whole or in specific domains in surveys (Kahneman & Krueger,
2006). SWB measures can also be evaluated by creating an index based on a series of
general statements (e.g. Pavot & Diener, 1993; WHO; 1998). Table 2.2 summarizes both
emotional well-being, Keith, Dobson, Goudy, and Powers (1981) included self-esteem
represent both positive and negative dimensions of mental health. Composite scores were
created by summing up responses to each scale and then standardizing for the purpose of
(1971), assuming that depression is a common condition of life and a fairly sensitive
indicator of life strains. Analogous to Derogatis et al., Kim and Mckenry (2002)
46
Author (s) Measurement (s) Score range
General Social Taken all together, how would you say things are these 1: Very happy
Survey1 days? Would you say that you are very happy, pretty happy, 3: Not too happy
or not too happy?
World Values All things considered, how satisfied are you with your life as 1: Dissatisfied
Survey2 a whole these days? 10: Satisfied
Eurobarometer On the whole, are you very satisfied, fairly satisfied, not 1: Not at all satisfied
Survey3 very satisfied, or not at all satisfied with the life you lead? 4: Very satisfied
Cantril (1965) Here is a picture of a ladder, representing the ladder of life. 0-10
Suppose we say the top of the ladder (step 10) represents the
best possible life for you, and the bottom (step 0) represents
the worst possible life for you. Where on the ladder do you
feel you personally stand at the present time?
Campbell, Converse, How do you feel about your life as a whole? 1-7
& Rodger (1976)
Mullis (1992) Six questions asking respondents’ levels of happiness in the 6-24
life domains of standard of living, housing, health, area of
residence and leisure time activities together with one
addressing the global dimension of “life in general”
1
Cumulative codebook of the General Social Survey. Available:
http://publicdata.norc.org:41000/gss/Documents/Codebook/FINAL%202006%20CODEB
OOK.pdf
2
WVS 2005 codebook. Available: http://www.worldvaluessurvey.org/
3
Survey data of the Eurobarometer Survey. Available: http://www.gesis.org/en/
services/data/survey-data/eurobarometer/eb-trends-trend-files/list-of-trends/life-satisf/?0=
47
2.4.2 Determinants of Well-Being
be beneficial for different outcomes such as labor market performance, health, and other
indicators (Hong & Swanson, 1995), with an unbalanced emphasis being put on income
due to the unavailability of wealth data and other information in the past. Generally,
education attainment was positively related to economic well-being (e.g. Park &
DeVaney, 2007; Hong & Swanson, 1995). Specifically, Becker (1975) focused on earned
income and examined how human capital increases one’s productivity in the workplace,
showing that individuals with higher education level earn more because of their higher
logical reasoning, and more specific job skills. Controlling for other variables, Hartog
and Oosterbeek (1998) indicated that schooling increases wealth, with individuals who
held non-vocational intermediate level of education having the highest scores in wealth.
Similarly, Baek and DeVaney (2004) argued that education investment was an important
predictor of savings and debt. In terms of physical well-being, empirical studies showed a
positive correlation between schooling and health. Hartog and Oosterbeek (1998) showed
evidence that schooling affects health, with the highest health status effect being realized
for higher secondary education. Berger and Leigh (1989) also found a relatively strong
the variation in health. Specifically, Behrman and Wolfe (1989) found a positive effect of
48
well-being. Hartog and Oosterbeek (1998), for instance, indicated that individuals with
happiness. The positive relationship between happiness and education was even stronger
in poor countries than in rich ones (Hartog & Oosterbeek, 1998; Veenhoven, 1996).
Consensus has reached an agreement that investors of risky financial assets expect
to earn higher return to accumulate their wealth and that there is a quantitatively large
association between economic status and health. However, little attention has been paid
Prather (1990) and Hong and Swanson (1995) stressed age effect on economic
well-being. Griffith (1985) and Mason and Griffith (1988) emphasized the importance of
life cycle, family status, economic status, economic environment, and individual
employment status, race, and marital status were found to be associated with economic
Age, gender, marital status, presence of children, and socioeconomic factors such
as family income, occupation status, and employment status were associated with various
49
measures of psychological well-being (e.g. Marks & Fleming, 1999; Williams, 1988). In
Kahneman and Krueger (2006), life satisfaction or happiness was positively related to
income and income rank in a reference group, and recent positive changes of
circumstance such as increased income and marriage. Previous studies showed that self-
Broadnax, 1994; Lewinsohn, Redner, & Seeley, 1991; Diener, 1984). Campbell (1981)
argued that self-esteem is the most powerful predictor of life satisfaction in terms of the
U.S. adults. Hong and Giannakopoulos (1994) found that self-esteem is the best predictor
of life satisfaction, supporting the notion that self-esteem helps defeat negative
Shaw (1996) is one of the few researchers who estimated a model with joint
investments in risky financial and human capital assets to indicate that risk-averse
individuals were less likely to invest in risky human capital that pays higher expected
future wage rates. To connect risk aversion with risky financial and human capital assets,
Shaw measured one’s risk aversion according to his/her allocation of wealth to risky
financial assets, assuming that each individual possesses a concave utility function that
can apply to both risky financial investment and risky human capital investment. The
intuition of the derived wage rate equation is that individuals who own a larger share of
financial wealth in risky assets are less risk-averse and consequently will invest more in
50
risky human capital, shifting upward the return to human capital investment.
Note that risk tolerance was measured objectively via actual risky financial asset
holding; therefore, Shaw’s (1996) study failed to account for the effect of risk tolerance
respect to risk tolerance cannot be determined if individuals did not own any risky
financial assets. Since most people invested in education when young or before investing
in risky financial assets, using share of financial wealth placed in risky assets as a proxy
for risk tolerance may not be appropriate for investigating the causal effect of risk
tolerance on human capital investment in the form of education. For this reason, Shaw’s
study may fail to answer the question that whether there is a casual relationship between
51
CHAPTER 3
THEORETICAL FRAMEWORK
A theoretical model that facilitates the examination into the determinants of risky
and discussed in this chapter. The expected utility model and the Capital Asset Pricing
Model are used in the current study. In the first section, utility is derived from the
demand for risky financial assets based on the expected utility model. In the second
section, demand for risky financial assets is derived from the determinants of risk-taking
behavior, namely risk tolerance, human capital, and total wealth, in term of the Capital
Asset Pricing Model. The third section presents a theoretical model that links risk
tolerance, risk-taking behavior, and individual well-being on the basis of the expected
utility model and the Capital Asset Pricing Model. Research hypotheses that are in line
with the theoretical model are presented and discussed in the fourth section.
The expected utility model was developed by von Neumann and Morgenstern
(1947). Based on the axiomatic foundations of the expected utility model, economists
began seeing the potential applications of expected utility to economic issues such as
52
portfolio choice, making it a widely-used method to analyze portfolio optimality (Hanna
& Chen, 1997) and the most powerful normative model for decision making under risk
(LeRoy & Werner, 2001; Schoemaker, 1982). The expected utility model is also a
classical way to evaluate the level of satisfaction of a decision maker who bears risk
(Gollier, 2001). The most straightforward and best-known applications of the expected
utility model tended to define utility on a single magnitude, namely income, wealth,
to maximize
u Ev v( A ) (3.1)
investors have no influence on ' s . The main idea of the expected utility model is that
an investor will select a choice with the highest expected values. The investor must
accept greater risk or at least greater volatility in order to obtain higher expected values.
The following step is to incorporate an investor’s choice, say, asset holdings with
Equation (3.1) needs to be justified under sufficient separability assumptions (Deaton &
53
Muellbauer, 1980). Suppose there is a two-period consumption model with consumption
vectors c1 and c 2 , where there is a weak separability in c 2 . Under the assumption of zero
subject to p 2 c2 ( A0 y1 p1 c1 ) (1 r ) y 2 A1 y 2
where A0 is initial wealth, r is the interest rate, p1 and p 2 are price of consumption in
period one and period two, respectively, and y1 and y 2 are income in period one and in
period is a function of ( A1 y 2 ) and p2 , and the mixed direct-indirect utility function is:
u vc1 , ( A1 y 2 , p2 ) (3.3)
Equation (3.3) can be expressed as Equation (3.4) if Equations (3.3) and (3.2) are
Based on the assumption that y 2 and p2 are constant with values that are optimal for c1 ,
the overall maximization must imply that A1 is allocated such as to maximize the second
term on the right-hand side of Equation (3.4), which in turn can be equivalent to Equation
54
significant role in the above specification, determining whether an investor is risk-averse
or risk-loving. Suppose different A ' s are different goods, the concavity of v(.) will
are convex to the origin (Deaton & Muellbauer, 1980). Specifically, suppose an investor
is considering buying fire insurance for a house and let A1 be wealth if the house is
burned down with the probability of and A2 (> A1 ) if no fire occurs. The situation
A1 and A2 in Figure 3.1. With a concave elementary utility function, say v , investors are
Comparing point D with point E, the concavity of the utility function implies that the
of pure risk-bearing. Obviously, if investors are generally averse to risk they would prefer
the certainty of the expectation of a random outcome to the uncertain prospect itself.
Since it is reasonable to assume that most individuals are risk-averse (Bailey, Olson, &
Wonnactoo, 1980), optimal behavior under risk can then be derived by assuming that the
risk-averse should maximize their expected utility with a utility function of wealth.
55
u
v( A2 ) C v( A)
v(EA) D
Ev
F E
v( A1 ) B
A1 A* EA A2 A
Arrow (1965) and Pratt (1964) have provided measures of risk aversion to
indicate the amount and the proportion of wealth an investor allocates to a risky assets
ARA refers to “twice the maximum premium the individual will pay to avoid one unit of
variance for very small risks (Deaton & Muellbauer, 1980).” With nonzero ARA, the
reciprocal of the ARA is a measure of risk tolerance (LeRoy & Werner, 2001).
56
Intuitionally, the rich are more risk tolerant than the poor with regard to the same risk,
resulting in the hypothesis of decreasing ARA (Arrow, 1965), which means that optimal
holding of risky assets increases with wealth. Numerous economists have also believed
that individual utility functions can be characterized by constant ARA (Friend & Blume,
1975).
Analogous to the ARA, the relative risk aversion (RRA), R , was defined as
RRA indicates “twice the premium per unit of variance of a bet when both premium and
bet are expressed as proportions of assets (Deaton & Muellbauer, 1980).” Arrow (1965)
hypothesized that investors ought to display increasing RRA with respect to wealth,
meaning that as wealth and the size of the risk increase, willingness to accept risk should
decline. That is, the proportion of wealth invested in risky assets decreases with wealth.
Note that the traditional view of increasing RRA has been questioned in recent years and
it was advocated that RRA is constant rather than increasing with respect to wealth
(Friend & Blume, 1975). Consistent argument was made by Hanna et al. (2001) that “the
utility function is usually assumed to be the constant RRA utility function” where the
estimations of risk aversion is derived from actual behavior such as asset allocation.
Under constant RRA hypothesis, individuals may have iso-elastic power utility function
A1 R
(v when R 1 ) or log utility function ( v ln(A) when R 1 ).
1 R
57
3.2 Capital Asset Pricing Model
The Capital Asset Pricing Model (CAPM) developed by Sharpe (1964), Litner
(1965), and Mossin (1966) is an equilibrium asset pricing model, providing a model for
individual investor behavior under conditions of risk and a precise prediction on the
relationship between expected return and risk of an asset. The CAPM has also become
the most popular model of security market equilibrium (Cohn et al., 1975). The CAPM
unsystematic risk (Focardi & Fabozzi, 2004). Systematic risk refers to the risk of holding
the market portfolio, indicating the degree to which an asset covaries with the market
portfolio and the portion of an asset’s variability that can be attributed to a common
factor. On the other hand, nonsystematic risk is the risk unique to an individual asset,
representing the portion of an asset’s variability that can be diversified away. Investors
are compensated only if they took systematic risk. In sum, investors’ net exposure is
merely systematic risk of the market portfolio due to the availability of diversification.
The CAPM is a ceteris paribus model and valid within a special series of
assumptions that reduce a complex situation to an extreme case (Focardi & Fabozzi,
2004), providing a set of equilibrium conditions that facilitate predicting the return on an
asset for its level of systematic risk. Investors would analyze securities and determine the
58
The followings are assumptions about characteristics of capital markets: Capital
markets are completely competitive and frictionless to all investors; there is a risk-free
asset available for investors either borrowing or lending at a risk-free rate; all assets are
perfectly divisible and priced, implying that human capital is non-existing since it is not
divisible and cannot be owned as an asset; taxes and transaction costs are irrelevant; and
information is freely and instantly available to all investors. Assumptions that deal with
the way investors make decisions are: Investors make decisions based on expected return
and its variance; investors are rational and risk-averse who maximizes the expected utility
of their end of period wealth, implying that investors must be compensated by the
opportunity of realizing a higher return to accept greater risk; risk-averse investors reduce
investors have the same expectations about expected return and variance of all assets.
disagree about the future prospects for securities in terms of education disparity or unique
personal characteristics; therefore, they may not have the same expectations about
expected return and variance of all assets. The introduction of human capital assets is also
In the CAPM, all investors will choose the market portfolio as their optimal
59
portfolio that includes all assets in the economy, with each asset being weighted in
proportion to its weight in the economy. Originally, since all investors have an agreement
on the estimates of securities’ expected returns, variances, covariances and the size of
risk-free rate, they face the same efficient set and would choose an identical risky
portfolio, which is on the efficient frontier that lies on the tangency line drawn from the
risk free asset. The demand for an asset would be zero and its price would approach zero
if the asset were left out of that portfolio; thus, all investors adjust their portfolio to
include this asset until it had a price that reflects its corresponding amount of risk. For
this reason, all assets will be included in each investor’s market portfolio.
In equilibrium, the market price of risk is expressed as a ratio of the expected risk
premium on risky assets to the variance of return on those assets which is equal to the
product of market value of all risky assets and a measure of ARA of an investor k ,
E (rm r f )
MVm ,k A,k (3.7)
m2
where rm and r f are the return on the market portfolio of all risky assets and on risk-free
asset, respectively, m2 is the risk of the market portfolio, MVm,k is the market value of all
risky assets, and A,k is the Pratt’s measure of RRA. Recall the relationship between the
Pratt’s measures of RRA and ARA, R ,k A,k Ak . Equation (3.7) can be rewritten as
E (rm r f ) R ,k MVm,k
MVm,k R ,k (3.8)
2
m Ak Ak
The proportion of wealth that an investor k allocates to the market portfolio can then be
60
expressed as Equation (3.9) by rearranging Equation (3.8).
E (rm r f ) 1
k (3.9)
2
m R ,k
where k denotes the proportion of the investor’s wealth allocated to risky assets.
Assuming that market price of risk (the fist term on the right-hand side of Equation (3.9))
holds constant across all investors, the only reason that investors choose a different
portfolio is because they have diverse indifference curves. In other words, investors will
choose distinct portfolios from the same efficient set according to their diverse
The basic CAPM in Equation (3.9) was further developed by Friend and Blume
(1975), who estimated RRA by maximizing an investor’s expected utility function using
a Taylor series expansion. Note that the original assumption that financial assets are
infinitely divisible and can be traded with zero transaction costs becomes problematic
when it is applied to human capital, the current study follows Friend and Blume to
redefine k as a ratio of liquid risky assets to liquid wealth (total wealth less human
wealth) and rm as the return on the market portfolio of liquid risky assets to introduce
human capital. Taking into account the dependence of k on the covariance between the
rate of return on the liquid market portfolio ( rm ) and the rate of return on human wealth
( rhk ), namely cov(rm , rhk ) , the ratio of liquid risky assets to liquid wealth is expressed as,
E (rm r f ) 1 1 hk
k hk ,m (3.10)
2
m R ,k (1 hk ) (1 hk )
61
where hk is the ratio of human wealth to total wealth of the investor k and hk ,m is the
ratio of cov(rm , rhk ) to m2 . In terms of Equation (3.10), the proportion of liquid wealth
wealth, total wealth, and cov(rm , rhk ) , given a fixed market price of risk.
Previous researchers (e.g. Fama & Schwert, 1977; Liberman, 1980) have argued
that hk ,m in Equation (3.10) was close to zero and this result was borrowed in empirical
studies for the purpose of simplicity (e.g. Schooley & Worden, 1996; Bajtelsmit et al.,
1999; Hariharan et al., 2000). Notice that the conclusion that human capital is weakly
related to the financial market was built on the assumption of a purely exogenously
determined human capital asset (Liberman, 1980). An alternative investment model that
explicitly allows for an endogenously determined human capital asset may predict a
significantly strong relationship between human capital assets and financial assets. For
this reason, the current study allows for a non-zero hk ,m . The total dollar amount of
Equation (3.10) by the value of liquid wealth ( Alk ) held by the investor k .
E (rm r f ) 1 1 hk
Fk k Alk hk ,m Alk (3.11)
m
2
R ,k (1 hk ) (1 hk )
The total dollar amount of liquid wealth allocated to risky financial assets is determined
by risk tolerance, human wealth, total wealth, and the ratio of cov(rm , rhk ) to m2 , holding
62
3.3 Specifications of Theoretical Model
The expected utility model implies that the utility of an investor depends on
his/her demand for risky financial assets and individual tastes or preferences. The utility
u k Ev( Fk ; P k ) (3.12)
where Fk denotes total dollar amount of risky financial assets held by the investor k and
Pk denotes a vector of preference factors. The utility function v(.) is defined for the
investor in the case of risk-taking behavior model. The investor who makes investment
decisions on risky assets will maximize a von Neuman-type expected utility function,
where Fk is a function of risk tolerance, human wealth, and total wealth of the investor,
with the relationship between risk tolerance and wealth being defined by the RRA. In
other words,
Fk F ( R ,k , H k , Ak ) (3.14)
Fk F ( R ,k , E k , Ak ) (3.15)
The function of risky financial assets can be substituted into the utility function to
63
express the investor’s utility as a function of risky financial investment.
u k Ev ( F ( R , k , E k , Ak ); Pk ) (3.16)
Note that the human capital is endogenously determined within the model when investors
were young and it is considered one type of risky assets that investors may hold;
E k E ( R ,k ; Pk ) (3.17)
Equation (3.16) can be rewritten as Equation (3.18). The ultimate goal of an investor is to
subject to PF Fk PE E k I k
where PF and PE are the prices of risky financial assets and human capital assets in the
Investors maximize their utility subject to the budget constraint determined by the
prices of risky assets and income level. Note that differences in prices and income do not
explain all of the disparities in decision making. Other variables such as age, gender, race,
and so forth of a particular investor “not only raise the ‘explanatory’ power of the
demand function, but also permit the effect of differences in prices and incomes to be
preferences. If different investors invest “differently after adjustment for prices and
income, the conclusion would have to be that their tastes differed (Becker, 1971).”
64
3.4 Hypotheses Development
section 3.3. Figure 3.2 depicts the structure of the theoretical framework, graphically
explaining the relationship between risk tolerance, risk-taking behavior, and well-being.
The theoretical framework is composed by three correlated parts. The first part examines
the impacts of risk tolerance on education investment. The second part explores the
impacts of risk tolerance and education investment on risky financial investment. The
third part focuses on how risk tolerance and risky investments in different domains
dimensions. The implications of the first and second parts will be integrated into the third
part analysis.
H1 Investment in
Education
(E) H3a, H3b H4a-H4c
Well-Being
Risk Tolerance Investment in ( WB )
( R ) Risky Financial Assets
H2a, H2b (F ) H5a-H5c
65
3.4.1 Part One: Determinants of Investment in Education
Even though the value of hk ,m has been demonstrated to be close to zero and a
group of researchers employed this result to explore different types of risky financial
asset holding assuming that human capital is a purely exogenously determined asset, a
human capital asset may relate to the financial market in terms of the pricing of financial
assets and portfolio composition in practice. Theoretically and empirically, human capital
investment is considered risky because investors may face uncertainty. In other words,
investment in education gives investors the right to receive a stream of risky dividend
payments in the future (Saks & Shore, 2005), playing a critical role in evolution of
(Christiansen et al., 2007), which is similar to the role of risky financial assets. For this
level that represents individual tastes or preferences for risks. This study hypothesizes
risk tolerance, holding all other factors constant. Note that the risks with respect to
education investment depend on one’s subjective adjustment which means that some
groups of people may consider education investment as a risky behavior and some of
them may view education investment as insurance. Therefore, the current study does not
H1: Holding all other factors constant, risk tolerance has a significant effect on
investment in education.
66
3.4.2 Part Two: Determinants of Investment in Risky Financial Assets
assets, the first order conditions of Equations (3.10)-(3.11) are differentiated with respect
to R ,k , respectively. First of all, the effect of risk tolerance on the ratio of risky assets to
k E (rm r f ) 1 1
2 . (3.19)
R ,k m2
(1 hk ) R ,k
Similarly, the effect of risk tolerance on the total dollar amount of liquid wealth allocated
to risky financial assets is derived by taking the first order condition with respect to R,k .
Fk E (rm r f ) 1 1
2 Alk . (3.20)
R ,k m2
(1 hk ) R ,k
investment in risky financial assets if the return on the market portfolio of all risky assets
is larger than that on risk-free asset, which is generally the case when the economic
E (rm r f ) 1 1
wealth allocated to risky financial assets decreases by 2 units as
2
m (1 hk ) R ,k
the level of risk aversion increases by one unit, with the other variables held constant.
Similarly, Equation (3.20) shows that the dollar amount of liquid wealth allocated to
E (rm r f ) Alk 1
risky financial assets decreases by 2 units as the level of risk
2
m (1 hk ) R ,k
aversion increases by one unit, holding the other variables constant. The negative impact
67
of risk aversion in both equations implies that a more risk tolerant investor will invest
more on risky financial assets in terms of proportion and dollar amount of liquid wealth.
H2a: Holding all other factors constant, risk tolerance has a significant effect on the
H2b: Holding all other factors constant, risk tolerance has a significant effect on dollar
associated with the present value of future earnings or discounted values of the average
labor income which are measures of human wealth. Individuals hold a greater amount of
human wealth because they have higher education level or more schooling, holding the
other variables constant. For this reason, the effect of education investment on risky
financial investments can be examined by taking the first order conditions of Equations
k E (rm r f ) 1 1
hk ,m (3.21)
hk m 2
R ,k (1 hk )
2
The first term on the right-hand side in Equations (3.21)-(3.22) determines the
E (rm r f ) 1
hk ,m is larger than zero, education investment boosts risky
m R ,k
2
68
financial investment. Investors who have more schooling allocate a larger proportion or a
greater amount of liquid wealth to risky financial assets. Otherwise, education investment
has a negative effect on risky financial investment, which means more educated investors
invest a smaller proportion or a smaller amount of liquid wealth to risky financial assets.
H3a: Holding all other factors constant, investment in education has a significant effect
H3b: Holding all other factors constant, investment in education has a significant effect
k E (rm r f ) 1 Hk
hk ,m (3.23)
Ak m2
R ,k ( Ak H k ) 2
Fk E (rm r f ) 1
hk ,m (3.24)
Ak m2 R ,k
Equation (3.23) presents a negative relationship between total wealth and the proportion
of liquid wealth allocated to risky financial assets if the first term on the right-hand side,
E (rm r f ) 1
namely hk ,m , is smaller than zero, implying that the proportion of
m2
R ,k
liquid wealth allocated to risky financial assets decreases as total wealth increases. On the
contrary, Equation (3.24) demonstrates a positive relationship between total wealth and
dollar amount allocated to risky financial assets if the term in the bracket is negative. A
wealthier investor allocates a greater amount of his/her liquid wealth to risky financial
69
assets. Likewise, the effect of preferences or tastes of one particular investor should be
determined in order to fully investigate the predictors of risky investment decision in the
financial market. The inclusion of variables such as age, gender, race, and so forth can
acquired through making decisions within the budget constraint. It is believed that
individuals are willing to take greater risks because they anticipate earning higher rates of
u k
first order condition of Equation (3.18) with respect to E k , namely . Similarly, in
E k
order to examine the effect of risky financial investments on individual well-being, the
u k u k
respectively, namely and . In general, income, consumption, and net worth are
k Fk
dimensions such as physical and psychological dimensions are also included to provide a
comprehensive picture for individual well-being. Assuming that individuals prefer more
to less, it is hypothesized that individuals who invest more in education and/or risky
70
financial assets have better economic, physical, and psychological well-being later in life.
H4a-H4c: Holding all other factors constant, investment in education has a significant
H5a-H5c: Holding all other factors constant, investment in risky financial assets has a
71
CHAPTER 4
The data and its sample design, and the sample used in the current study are
4.1 Data
directed by the Bureau of Labor Statistics of the U.S. Department of Labor, is a randomly
selected nationally representative sample of 12,686 young persons who were 14-22 years
old when they were first interviewed in 1979. Subsequent interviews were conducted
every year through 1994 and biennially from 1996 to present. These individuals are now
in their early forties to early fifties and have been interviewed for nearly three decades.
Twenty-two of the survey waves have been released to provide detailed information on
how individuals change their life over time. Note that the majority of surveys available
have concentrated on the rich or older adults, the NLSY79 pays a great deal of attention
to a group of people who are at the stage of building physical and human wealth, namely
72
The NLSY79 contains two independent civilian samples and an independent
non-institutionalized civilian youth population living in the U.S. in 1979 and born
non-Hispanic US youths living in the U.S. in 1979 and born between 1957 and 1964; and
a sample of 1,280 respondents who represent the population born between 1957 and 1961
that were enlisted in one of the four branches of the active military forces as of 1978
(Zagorsky, 1999). While merely a few micro level data sets are available for analyzing
the U.S. experience (Wolff, 1996), the NLSY79 data chronicle the transitions made by
respondents such as finishing their schooling, moving out of their parents’ homes,
the military, getting married, starting their own families, and becoming home owners
during the years since they were first interviewed, making it possible to investigate these
Additional questions on a variety of related topics that change from year to year are
contained in the NLSY79: Family income and assets, health conditions, geographic
characteristics. Due to much broader interests of governmental agencies besides the U.S.
Department of Labor, the NLSY79 also included other topical areas in selected years
73
such as the 1980 Armed Service Vocational Aptitude Battery and a self-report
supplement to the 1980 survey data on delinquent and criminal activities. The wealthy
data set makes it possible to derive risk tolerance based on illegal activity participation, to
examine investments in risky financial assets and education, and to measure individual
well-being later in life. Likewise, the NLSY79 includes a set of hypothetical income risk
questions, which are similar in structure to those in the 1992 HRS, for categorizing
respondents according to their respective risk tolerance. All of the NLSY79 respondents
were asked to respond to these hypothetical questions in 1993, 2002, and 2004, and the
numbers of responses were 8,945 in 1993, 7,485 in 2002, and 7,176 in 2004, with 6,453
To sum up, the NLSY79 has its advantage in studying young baby boomers. First,
the NLSY79 provided various information on young baby boomers who had just started
their new life stage and followed these boomers during the period when they were
primarily making choices of financial investment and education investment. Second, not
only can the data on illegal activity participation at an early life stage be used to create
indices for risk tolerance but the longitudinal data provide the capacity to construct a
following respondents over time and, thereby, better separate out risk-taking behavior
due to demographic characteristics and risk tolerance. Moreover, the NLSY79 is one of
the few longitudinal surveys that collect complete wealth information of a host of
individuals. Husband and wife were asked separately about their income, asset, debt,
liability, and wealth; thus, investigation into the relationship between risk tolerance, risk-
74
taking behavior, and well-being can be conducted at an individual level. Last, the
participation rate was high (Zagorsky, 1999) and methods used to contact individuals
who missed an interview and to bring them back into the survey has reduced attrition.
Respondents who were brought back into the survey were asked to report information
The NLSY79 used a complex sampling design that includes stratification and
clustering for all civilian samples. The process of a multi-stage stratified area probability
sampling involved several stages such as the selection of primary sampling units (PSUs),
districts-block groups (BGs), and sampling listing segments (Eberwein, Olsen, & Reagan,
2003). The first stage of the sample selection involved selecting an area sample of PSUs,
which furnished the sampling frame for the next stage. Within PSUs, BGs were formed
based on median income and percentage black. The supplemental sample also stratified
on the relative population size of the three target groups. Within each BG, sampling
listing segments were formed, followed by obtaining a sample of dwelling units within
listing segments and individual quarters from the segments. The NLSY79 also
The military sample was selected from up-to-date lists of all personnel on active
75
females were oversampled at roughly six times the rate for males to produce
approximately equal numbers of males and females in the final sample. First of all, a
sample of military units was selected with probabilities proportional to the number of
persons born between 1957 and 1961 and serving in the military units as of September 30,
1978. Within selected units, persons born in 1957 through 1961 were sub-sampled with
The sample for this study consists of the young baby boomers who participated in
all of the 1979, 1980, 1981, 1993, 2000, 2002, 2004, and 2006 waves in order to portray
controlling for all other variables. The selection of sample is presented in Figure 4.1.
The original size of the NLSY79 was 12,686. Budgetary constraint prevented
1,079 members of the military subsample and 1,643 members of the supplemental sample
from being eligible for interview after the 1984 wave and the 1990 interview,
respectively, generating a smaller sample with size of 9,964 respondents in the first place
respondents, and respondent decease make the sample size decreases by year, resulting in
a relatively smaller size of 7,654 respondents in 2006 compared to the initial number.
76
1979 NLSY79
(N= 12,686)
77
The quantity of missing values which is one of the measures of data quality is
taken into consideration to satisfy the need for accuracy and trustworthiness of statistical
results (Zagorsky, 1999). In the 2006 wave, the number of respondents who provided full
information about their well-being measures in each dimension was 6,782, with 305, 296,
36, and 235 respondents being dropped from the sample sequentially due to missing
values in current earned income, family income, Physical Component Summary score,
Rosenberg’s self-esteem scales, and Mental Component Summary score. This procedure
report the highest grade completed in 2004 were not selected, resulting in a sample size
in 2004 dropped 354 respondents from the sample, resulting in a sample of size 5,815. In
addition, 657 respondents did not completely answer a series of questions that indicate
their total wealth, total family income, tastes and preferences, including age, marital
status, self-employment status, presence of children, family size, inherited wealth, and
home ownership, and control variables such as region of residence and Standard
The same procedure was applied when selecting variables in the 2002, 2000, 1993,
1981, 1980, and 1979 waves. First, 4,845 respondents out of 5,158 answered the 2002
hypothetical income risk questions, dropping 6.1 % of respondents. In the 2000 wave,
299 respondents failed to provide net worth information, resulting in dropping roughly
78
6.2% of the respondents. The 1993 hypothetical income risk questions dropped another
75 respondents. Respondents who did not respond to the illegal activity participation
questions in 1980 were excluded. This criterion resulted in dropping 9.2 % of the
respondents, leaving 4,059 respondents for data analysis. Country of birth and region of
completed by the oldest sibling altogether dropped 618 respondents. This sample
selection process ultimately generates a sample size of 3,425 respondents for further data
analysis.
Univariate, bivariate, and multivariate analyses are used in this study. First,
univariate analysis were used to explore level of risk tolerance, risky investment
decisions such as risky financial investment and education investment, and well-being in
terms of income, health status, and self-esteem separately, without controlling for any
other variables. Second, bivariate analysis is employed to determine how some variables
79
estimation results, and has the ability to capture all the direct effects from the included
variables, regression analysis fails to deal with any indirect impacts coming from causal
relationships among the variables included (Ahn, 2002). It is very likely that education
investment and investment in risky financial assets are jointly determined by a set of
terms. Additionally, risk tolerance may exert its impact on risky financial investments via
education investment based on regression analysis may result from ignoring various
investment.
equations with each equation being related to the others by either endogenous variables
accounts for joint decision making of an individual regarding human capital assets and
E k 0 1 R ,k 2 X E ,k u k (4.1)
Fk 0 1 R ,k 2 E k 3 X F ,k v k (4.2)
WBk 0 1 E k 2 Fk 3 X WB ,k wk (4.3)
where R,k , E k , Fk , and WBk denote the level of risk tolerance, education investment,
80
and X WB ,k are vectors of preference characteristics and control variables, and u k , v k , and
wk are disturbances, capturing the respective unobservable factors that govern decisions
to invest in education and risky financial assets and the level of well-being. In this
structural model, E k , Fk , and WBk are continuous endogenous variables because they are
determined inside the model, R,k , X E ,k , X F ,k , and X WB ,k are exogenous because they
are determined outside the model, and ' s , ' s , and ' s are the coefficients of these
endogenous variables.
model is presented in Equations (4.4)-(4.6), specifying how the value of each endogenous
variable is related to the values of the exogenous variables, the disturbances, and the
structural coefficients.
E k 10 11 R , k 12 X E ,k 1k (4.4)
Fk 20 21 R , k 22 X E ,k 23 X F ,k 2 k (4.5)
WBk 30 31 R ,k 32 X E ,k 33 X F ,k 34 X WB ,k 3k (4.6)
where coefficients are complex combinations of ' s , ' s , and ' s and ' s are
equations are considered the best candidates for instrumental variables because they are
correlated with the endogenous variables and uncorrelated with the disturbance. In order
to create a best instrumental variable that is highly correlated with the regressor for which
81
it is acting as an instrument, it is suggested to first regress each endogenous variable that
acts as a regressor in the equation being estimated on all of the exogenous variables in the
system of simultaneous equations and then calculate the estimated values of these
endogenous variables. Note that the two instrumental variables, Ê k and F̂k , will not be
correlated with the error term in the model. In turn, the estimated values of these two
endogenous variables are used as the required instrumental variables for these
E k 0 1 R ,k 2 X E ,k u k (4.7)
Fk 0 1 R ,k 2 Eˆ k 3 X F , k v k (4.8)
Individual Well-Being
the 2006 wave are the first set of dependent variables to provide a more comprehensive
picture for understanding the impacts of risky decisions in the financial market as well as
According to Mullis (1992), current earned income and family income are
comes from military service, wages, salary, commissions, and tips, and businesses and/or
82
professional practices. Family income includes current earned income plus government
transfers and welfare payments, private transfers such as child support, alimony and gifts,
and other sources, including scholarships, interest, dividends and rent (Zagorsky, 2003).
analysis at an individual level. Note that the two indicators of economic well-being are
captured by the Physical Component Summary score (PCS-12) from the Short-Form-12
(SF-12) designed to measure general health status from an individual’s point of view. A
PCS-12 score is a continuous variable ranging from 0 to 100, with higher scores
indicating better physical health. While direct indicators of psychological well-being are
not available, this study employs self-esteem as a proxy for happiness or life satisfaction
because self-esteem was considered a powerful predictor of life satisfaction (Hong &
instrument (See Appendix A), which is by far the most widely-used instrument (Robins,
Hendin, & Trzesniewski, 2001), tracking how much individuals believe they are capable,
satisfied and proud versus how much they view themselves as useless or a failure.
Responses to item one, two, four, six, and seven are reversed coded and responses to the
ten items are then summed up in one value. The self-esteem measure ranges from 10 to
40, with higher scores representing a higher level of self-esteem. Mental Component
Summary score (MCS-12) from the SF-12 is the other psychological well-being
83
indicator. Analogous to a PCS-12 score, a MCS-12 score ranges from 0 to 100, with
market. Definitions of risky assets are diverse in literature, with stocks, bonds, and
mutual finds being the common components (See Table 4.1). As for risky financial
investment, it was captured by ratio of risky assets to wealth (e.g. Jianakoplos &
Bernasek, 1998; Schooley & Worden, 1996), ratio of risky assets to net worth (e.g.
Bajtelsmit et al., 1999; Friend & Blume, 1975), ratio of risky asset to financial assets (e.g.
Hariharan et al., 2000; Shaw, 1996;), share of one particular risky asset in financial
wealth (e.g. Kimball et al., 2005; Barsky et al., 1997), share of risky assets in total assets
(Xiao et al., 2001), or actual stock ownership (e.g. Sahm, 2007; Heaton & Lucas, 2000).
84
Author (s) Data Risky Assets
Sahm (2007) The 1992-2002 HRS Corporate stocks (exclusive of stocks in IRAs or DCs);
mutual funds and investment funds
Brown, Garino, The 2001 PSID Stock in publicly held corporations, mutual funds or
et al. (2006) investment trusts
Gutter & Fontes The 2004 SCF Stocks; stock mutual funds; stock or stock funds held in
(2006) pensions; owned business assets
Guiso & Paiella The 1995 SHIW Private bonds; stocks; mutual funds
(2004)
Hariharan et al. The 1992 HRS Stock in publicly held corporations, mutual funds or
(2000) investment trusts; corporate, municipal, government,
foreign bonds and bond funds
Bajtelsmit et al. The 1989 SCF Balances in IRAs not invested in bank deposits; stock
(1999) holdings less margin loans outstanding; bonds; trust
assets; real estate other than residential housing;
businesses owned; other miscellaneous assets; the
balances in defined contribution pension
Wang & Hanna The 1983-1989 SCF All real estate held for investment purposes; total value of
(1997) business assets; mutual funds; corporate stocks; precious
metals; pension assets in the forms of stocks, bonds, and
mutual funds
Schooley & The 1989 SCF All real estate held for investment purposes; mutual
Worden (1996) funds; corporate stock; precious metals; corporate and
government bonds; amounts accumulated in all other
pension accounts; loans to individuals; an estimate of
human capital
Morin & Suarez The 1970 Canadian Stocks, bonds, and mutual funds; real estate other than
(1983) SCF owner-occupied home; equity in own business; loans held
85
Following Heaton and Lucas (2000), Guiso and Paiella (2004), Hariharan et al.
(2000), Kimball et al. (2005), and Barsky et al. (1997), this study uses two continuous
portfolio composition. The first indicator is the ratio of risky financial assets to financial
assets, where risky financial assets include stocks, corporate bonds or government
securities, and mutual funds and financial assets is calculated by summing up total dollar
corporate, municipal, government, foreign bonds and bond funds, in all shares of stock in
publicly held corporations, and in mutual funds or investment trusts (Rosen & Wu, 2003;
Hariharan et al., 2000). The second indicator is dollar amount of stocks which is held by
a respondent. All of the asset and wealth data were collected from the 2004 wave.
Investment in Education
attainment (See Table 4.2). The current study employs a continuous variable of years of
86
Author (s) Measures
Belzil & Leonardi (2007) Schooling attainments (six ordered levels):
(1) no education
(2) elementary school (attained at 11 years of age)
(3) junior high school (attained at 14 years of age)
(4) high school (attained at 18 years of age)
(5) university degree (attained at 23-24 years of age)
(6) post-university degree
(the last two categories being combined into college degree or more)
Carneiro, Hansen, & Heckman (1) had graduated from a four year college:
(2003) -having a college degree or having completed more than 16 years in
school
(2) had graduated from high school:
-having a high school degree or having completed 12 grades and
never reported college attendance
87
Variables Measurement
Measures of Well-Being in 2006 ( WB )
Current earned income ($) Log of current earned income of respondent
Family income ($) Log of family income of respondent
Physical Component Summary score Summary score for a brief inventory of self-reported physical
health of respondent
Self-esteem score Self-esteem score of respondent
Mental Component Summary score Summary score for a brief inventory of self-reported mental
health of respondent
Risky Financial Investment in 2004 ( F )
Ratio of risky financial assets to Ratio of risky financial assets to financial assets of respondent
financial assets
Dollar amount of stocks ($) Log of dollar amount of stocks held by respondent
Education Investment in 2004 ( E )
Years of schooling Number of years of schooling of respondent
Objective measures of risk tolerance in 1979
Stealing Risk tolerance derived from items 1, 3, 4, 5, 14, 15, and 16
Drug use and sales Risk tolerance derived from items 9, 10, and 11
Fighting and attacking Risk tolerance derived from items 2, 7, 8, and 13
Earning criminal income Risk tolerance derived from items 6, 12, 17, and 18
Survey-based risk tolerance in 1993
Most risk tolerant 1 = respondent was most risk tolerant in 1993; 0 = otherwise
Moderately risk tolerant 1 = respondent was moderately risk tolerant in 1993; 0 =
otherwise
Weakly risk tolerant 1 = respondent was weakly risk tolerant in 1993; 0 =
otherwise
Least risk tolerant 1 = respondent was least risk tolerant in 1993; 0 = otherwise
Survey-based risk tolerance in 2002
Most risk tolerant 1 = respondent was most risk tolerant in 2002; 0 = otherwise
Continued
88
Table 4.3 Continued
Variables Measurement
Moderately risk tolerant 1 = respondent was moderately risk tolerant in 2002; 0 =
otherwise
Weakly risk tolerant 1 = respondent was weakly risk tolerant in 2002; 0 =
otherwise
Least risk tolerant 1 = respondent was least risk tolerant in 2002; 0 = otherwise
Survey-based risk tolerance in 2004
Most risk tolerant 1 = respondent was most risk tolerant in 2004; 0 = otherwise
Moderately risk tolerant 1 = respondent was moderately risk tolerant in 2004; 0 =
otherwise
Weakly risk tolerant 1 = respondent was weakly risk tolerant in 2004; 0 =
otherwise
Least risk tolerant 1 = respondent was least risk tolerant in 2004; 0 = otherwise
Net Worth in 2004 ( W2004 ) Net worth of respondent in 2004
Income ( I )
Total family income Log of total family income of respondent in 2003
Preference Characteristics ( P )
Age Age of respondent in 2004
Male 1 = respondent is male; 0 = female
Race and ethnicity
Non-Black, non-Hispanic White 1 = respondent is non-Black, non-Hispanic White and other; 0
and other = otherwise
Hispanic 1 = respondent is Hispanic; 0 = otherwise
Black 1 = respondent is Black; 0 = otherwise
Married in 1980 1 = respondent was married in 1980; 0 = otherwise
Presence of children in 1980 1 = respondent had any children in 1980; 0 = otherwise
Individual ability Armed Force Qualification Test scores of respondent in 1981
Education level of father Number of years of schooling of respondent’s father
Continued
89
Table 4.3 Continued
Variables Measurement
Education level of mother Number of years of schooling of respondent’s mother
Number of siblings Number of siblings respondent had in 1979
Education level of oldest sibling Number of schooling of the oldest sibling in 1979
Marital status2004
Married 1 = respondent was married in 2004; 0 = otherwise
Never married 1 = respondent was never married in 2004; 0 = otherwise
Separated, divorced, or widowed 1 = respondent was separated, divorced, or widowed in 2004;
0 = otherwise
Self-employed in 2004 1 = respondent was self-employed in 2004; 0 = otherwise
Presence of children2004 1 = respondent had any children in 2004; 0 = otherwise
Family size Number of people having qualifying relationships in
household in 2004
Inherited wealth 1 = respondent received any property or money from any
estates, trusts, inheritances, or gifts from relatives, or received
settlement from life insurance in 2004; 0 = otherwise
Primary home ownership 1 = respondent owned/bought the house/apartment in which
he/she lived in 2004; 0 = otherwise
Secondary home ownership 1 = respondent owned any other property such as a second
home or a time-share in 2004; 0 = otherwise
Control Variables ( X E , X F , X WB )
Region of residence
Northeast 1 = respondent lived in the Northeast in 2004; 0 = otherwise
North Central 1 = respondent lived in the North Central region in 2004; 0 =
otherwise
South 1 = respondent lived in the South in 2004; 0 = otherwise
West 1 = respondent lived in the West in 2004; 0 = otherwise
SMSA 1 = respondent lived in SMSA in 2004; 0 = otherwise
Born in the US 1 = respondent was born in the U.S.; 0 = otherwise
Lived in Urban area at age 14 1 = respondent lived in urban area at age 14; 0 = otherwise
90
4.5.2 Independent Variables
Two methods are used to derive individual risk tolerance. Following previous
studies (e.g. Fairlie, 2002; Barsky et al., 1997), individuals’ responses to the frequency of
participating in 17 illegal activities which may be against the rules or the law plus one
illegal income question in 1979 are used to create indices of risk tolerance. In each illegal
activity question (See Appendix B), respondents were asked to choose one among the
seven categories which best described the number of times they have engaged in each
activity. In the illegal income question, respondents reported the proportion of their total
income that came from illegal activities by choosing one within the six categories.
analysis (PCA), which is a data reduction technique that transforms the original set of 18
activities into a new set of uncorrelated linear combinations of the original activities,
namely the principal components (Meyers, Gamst, & Guarino, 2006). In the first step, the
activities. According to eigenvalue criterion and the result of Scree test, four components
are retained. A rotated component matrix is then created to indicate the weights of the 18
activities and the relationship between each of the activities contained in the linear
combination and the component as a whole, where each component represents a set of
activities that are relatively strongly related to each other. The last step is to sum up the
scores of activities that load on the same component in order to create a continuous,
91
objective measure of risk tolerance. This method generates four indices of risk tolerance:
Stealing, drug use and sales, fighting and attacking, and earning criminal income.
hypothetical income risk questions in the 1993, 2002, and 2004 waves. All of the
“Suppose that you are the only income earner in the family, and you have a good job
guaranteed to give you your current (family) income every year for life. You are given the
opportunity to take a new and equally good job, with a 50-50 chance that it will double
your (family) income and a 50-50 chance that it will cut your (family) income by a third.
The NLSY79 offered respondents who are willing to take the new job another option:
“Suppose the chances were 50-50 that it would double your (family) income and 50-50
that it would cut it in half. Would you still take the new job?”
For respondents who are not willing to take the new job, the NLSY79 asked them:
“Suppose the chances were 50-50 that it would double your (family) income and 50-50
that it would cut it by 20 percent. Would you take the new job?”
Responses to these hypothetical questions classify respondents into one of the following
categories (See Figure 4.2) that follows Rosen and Wu (2003) and Spivey (2007): Most
risk tolerant (if respondents accepted both offers in the first and second gambles);
moderately risk tolerant (if respondents accepted the first offer but rejected the second
one); weakly risk tolerant (if respondents refused the first offer but accepted the third
one); and least risk tolerant (if respondents refused the first and third offers).
92
Gamble 1 (cut income by 1/3)
New Old
One concern for this method is that most respondents answered the questions
when they have finished their education (Chen, 2003), making it difficult to determine if
risk tolerance varies with education level or the opposite. Even though respondents are
likely to answer questions depending on specific risk tolerance, accumulated wealth, and
background risk as perceived in the same year when these questions were asked (Belzil &
Leonardi, 2007), this survey-based measure is useful for tracking risk tolerance pattern
and understanding the relative explanatory powers of risk tolerance measures captured at
93
Net Worth and Total Family Income
The 2000 net worth is a continuous predictor of risky financial investments. Net
Worth measured as the sum of the net value of risky and risk-free assets is calculated
according to Zagorsky (2007) that is consistent with previous studies (e.g. Hariharan et
al., 2000; Bajtelsmit et al., 1999): sum of home value, cash saving, values of stocks,
bonds, and mutual funds, trusts, value of business (farm) assets, car value, possession
value, and values of IRA, 401K, and CDs, minus mortgage value, property debt value,
business (farm) debts, car debt, and other debts. Total family income relates to demand
for risky financial assets because it represents economic resources held for consuming,
saving, or investing. The 2003 total family income is measured as a continuous predictor
that follows Sahm (2007), Kimball et al. (2005), and Xiao et al. (2001). This study uses
natural logarithm transformation because the distribution of total family income is right-
skewed. Net worth in 2004 and total family income in 2003 are also included to predict
physical well-being and psychological well-being in 2006, with the 2003 total family
income being logarithmic transformed. This study does not include these two variables in
the economic well-being equation because the main purpose is to examine individual
well-being at a specific time point, rather than the change of well-being across time.
94
that most respondents received education when young and the accumulated human
capital influences their risky financial investment decision because the educated are
conceptual framework as depicted in Figure 3.2, the ratio of financial assets that was
securities, and mutual funds, and dollar amount of stocks held by an respondent in 2004
are not only dependent variables but also independent variables to explain individual
Preference Factors
theoretical of risky decision making, the current study includes vectors of exogenous
(4.1)-(4.3) includes age, gender, and race and ethnicity which were collected in the 2004
indicating whether a respondent is male or female. A race and ethnicity variable classifies
parental education, the number of sibling, and education level of the oldest sibling. A
marital status variable indicates whether a respondent was married in 1980. The presence
95
of children variable indicates whether a respondent had any children in 1980. The
respondents’ ability is evaluated using the Armed Force Qualification Test (AFQT)
scores that consist of four tests such as a vocabulary test, a mathematics test, a reading
comprehension test, and an analytical test because these scores are highly correlated with
general intelligence. While the AFQT score is a good indicator of general intelligence, it
strongly positively correlates with age, which means older respondents are considered
more intelligent than younger ones (Zagorsky, 2007). The current study follows
Zagorsky’s regression framework to recalculate an AFQT score that adjusts to one’s age.
Parental education (father and mother), number of siblings, and the highest grade
Equation (4.2) includes family size, inherited wealth, primary home ownership, and
secondary home ownership in 2004. A marital status variable classifies respondents into
indicates whether a respondent had any children. Family size is measured as a continuous
respondent received any property or money from any estates, trusts, inheritances, or gifts
from relatives, or received settlement from life insurance. Primary home ownership is
96
house or apartment in which he/she lived. Secondary home ownership variable indicates
presence of children in 2004, and family-level information such as family size in 2004
Control variables
to capture whether a respondent lived in the Northeast, the North Central region, the
South, or the West in 2004. Region of residence at age 14 is a unique control variable in
Equation (4.1), indicating whether a respondent lived in an urban area or not at age 14.
SMSA status and country of birth are unique control variables in Equation (4.3). SMSA
status indicates whether a respondent lived in an SMSA or not in 2004. Country of birth
is measured as a categorical variable to capture whether a respondent was born in the U.S.
or in other countries.
This section describes the young baby boomer generation in terms of their
decisions in risky financial assets and human capital in the form of education, the level of
risk tolerance, net worth, total family income, and preference characteristics. Table 4.4
presents the characteristics of the young baby boomer sample used in the current study.
97
Frequency/ Mean
Variables S.E.
Percent (median)
Measures of Well-Being in 206 ( WB )
Current earned income ($) $45,803 $51,127
($35,000)
Family income ($) $46,583 $41,966
($38,000)
Physical Component Summary score 52.50 7.55
(55.26)
Self-esteem score 33.79 4.34
(34.00)
Mental Component Summary score 53.42 7.83
(55.87)
Risky Financial Investment in 2004 ( F )
Ratio of risky financial assets to financial assets 0.44 0.47
(0.00)
Dollar amount of stocks ($) $21,818 $146,033
($0.00)
Education Investment in 2004 ( E )
Years of schooling 13.63 2.43
(13.00)
Objective measure of risk tolerance in 1979
Stealing 0.20 0.36
(0.00)
Drug use and sales 0.68 1.03
(0.00)
Fighting and attacking 0.36 0.52
(0.25)
Earning criminal income 0.09 0.27
(0.00)
Continued
98
Table 4.4 Continued
Frequency/ Mean
Variables S.E.
Percent (median)
Survey-based risk tolerance in 1993
Most risk tolerant 789 / 23.04
Moderately risk tolerant 597 / 17.43
Weakly risk tolerant 455 / 13.28
Least risk tolerant 1,584 / 46.25
Survey-based risk tolerance in 2002
Most risk tolerant 568 / 16.58
Moderately risk tolerant 557 / 16.26
Weakly risk tolerant 381 / 11.12
Least risk tolerant 1,919 / 56.03
Survey-based risk tolerance in 2004
Most risk tolerant 491 / 14.34
Weakly risk tolerant 492 / 14.36
Moderately risk tolerant 594 / 17.34
Least risk tolerant 1,848 / 53.96
Net Worth in 2004 ( W2004 ) $228,535 $429,766
($96,500)
Net Worth in 2000 ( W2000 ) $158,724 $334,625
($58,650)
Income ( I )
Total family income in 2003 $72,266 $67,156
($58,613)
Preference Characteristics ( P )
Age of respondent in 2004 43.05 2.22
(43.00)
Male 1,681 / 49.08
Race and ethnicity of respondent
Non-Black, non-Hispanic Whites and others 2,054 / 59.97
Continued
99
Table 4.4 Continued
Frequency/ Mean
Variables S.E.
Percent (median)
Hispanic 584 / 17.05
Black 787 / 22.98
Married in 1980 418 / 12.20
Presence of children in 1980 334 / 9.75
Individual ability of respondent 36.67 28.78
(35.10)
Education level of respondent’s father 11.12 3.86
(12.00)
Education level of respondent’s mother 11.15 3.05
(12.00)
Number of siblings of respondent 3.60 2.51
(3.00)
Education level of oldest sibling of respondent 12.69 3.57
(12.00)
Marital status in 2004
Married 2,191 / 63.97
Never married 477 / 13.93
Separated, divorced, or widowed 757 / 22.10
Self-employed in 2004 288 / 8.41
Presence of children in household in 2004 2,321 / 67.77
Family size of respondent in 2004 3.16 1.53
(3.00)
Received inheritance in 2004 272 / 7.94
Primary home owned in 2004 2,446 / 71.42
Secondary home owned in 2004 344 / 10.04
Control Variables ( X E , X F ,
X WB )
Region of residence in 2004
Northeast 469 / 13.69
Continued
100
Table 4.4 Continued
Frequency/ Mean
Variables S.E.
Percent (median)
North Central 923 / 26.95
South 1,356 / 39.59
West 677 / 19.77
Lived in urban area at age 14 2,663 / 77.75
SMSA 2,798 / 81.69
Born in US 3,230 / 94.31
Note: Sample size = 3,425.
Individual Well-Being
Among the 3,425 young baby boomers, the mean and median values of current
earned income in 2006 are $45,803 and $35,000, respectively, and the means and median
values of family income at an individual level in 2006 are $46,583 and $38,000,
income. That is, most of the young baby boomers have a smaller amount of earned
income and family income while there are a few who have exceptionally a large amount.
Note that the standard deviations of both indicators also show a substantial dispersion in
economic well-being across the young baby boomers. Despite inequality, the two
indicators suggest that the young baby boomers have better economic well-being than
those in terms of the earlier SCF data (e.g. Hong & Swanson, 1995) while they have
worse economic well-being compared to those in terms of the more recent SCF data (e.g.
Park & DeVaney, 2007). In terms of physical well-being, the young baby boomers have
101
the mean value of PCS-12 score of 52.50 in 2006 which is larger than 50.00, indicating
better physical health of these boomers compared to a typical person in the general U.S.
population. As for psychological well-being, the mean value of self-esteem score in 2006
is 33.79, with its value ranging from 15.00 to 40.00. Generally, the young baby boomers
have slightly higher self-esteem compared to other groups of people such as college
students (e.g. Crocker et al., 1994) or patients with certain diseases; however, self-esteem
of the U.S. general population is absent for comparison. The mean value of MCS-12
score in 2006 is 53.42, which means the young boomers have better mental health when
compared to a typical person in the general U.S. population. Altogether, the young baby
boomers as a whole have higher PCS-12 and MCS-12 scores than the general U.S.
The mean value of the ratio of risky financial assets to financial assets was 0.44
among the young baby boomers. In line with previous findings (e.g. Kimball et al., 2005),
a significant proportion (52.06%) of the young baby boomers did not hold any share of
financial assets in stocks, corporate bonds or government securities, and mutual funds in
2004. Compared with other groups of people, the young baby boomers as a whole held a
larger proportion of financial assets in risky financial assets than did single females
(Jianakoplos & Bernasek, 1998) while they had a relatively smaller proportion of
financial assets held in the form of risky financial assets than single males, married
102
couples (Jianakoplos & Bernasek, 1998), and older adults (e.g. Hariharan et al., 2000).
The mean and median values of dollar amount of stocks held by the young baby boomers
in 2004 were $21,818 and $0, respectively, with its deviation of $146,033 and its range of
$7,225,800, indicating inequality with respect to stock holding across the young baby
boomers.
Investment in Education
The average years of schooling of the young boomers was 13.63 (s.d. = 2.43). All
of these boomers had at least three years of schooling and roughly 2% have 20 years of
(e.g. Hariharan et al., 2000; Brown & Taylor, 2006), the young baby boomers on the
average had slightly higher education level regarding years of schooling. According to
the diploma received, the majority of the young baby boomers (93.34%) had at least a
high school degree (who had completed 12 years or more in school). More than one-
fourth (26.36%) had some college education (who had completed 13 to 15 years of
schooling in school) and 14.42% had a college education (who had completed 16 years in
school). Approximately 12% had post college education (who had completed 17 years or
more in school). The descriptive results indicate that a relatively larger proportion
(40.76%) of the young baby boomers had a high school degree while a rather smaller
proportion (26.25%) of them had college degree or higher compared to baby boomer
generation as a whole (Baek & DeVaney, 2004) or the SCF samples (e.g. Wang & Hanna,
2007).
103
Risk Tolerance
Two sets of measures of risk tolerance are provided in this study. The first set is
derived according to the responses to 17 illegal activity participation questions plus one
illegal income question in 1979. Four indices of risk tolerance are generated in light of
the PCA results, including stealing (based on 7 illegal activities), drug use and sales
(based on 3 illegal activities), fighting and attacking (based on 4 illegal activities), and
earning criminal income (based on 4 illegal activities). The mean value of risk tolerance
with respect to stealing was 0.20, ranging from 0.00 to 3.57 (s.d. = 0.36). The mean value
of risk tolerance in terms of drug use and sales was 0.68, ranging from 0.00 to 5.00 (s.d.
= 1.03). The range of risk tolerance regarding fighting and attacking was from 0.00 to
4.25, with its mean value of 0.36 and its deviation of 0.52. The value of risk tolerance in
terms of earning criminal income ranged from 0.00 to 3.75, with its mean value of 0.09
and its deviation of 0.27. The four indices consistently show an extremely low level of
The second set of risk tolerance measures is derived from the hypothetical income
risk questions in 1993, 2002, and 2004 waves. In terms of responses to these income risk
questions in 1993, roughly 46% of the young baby boomers were classified as the least
risk tolerant and approximately one-fifth (23.04%) of them were the most risk tolerant in
1993. The patterns of risk tolerance distribution in 2002 and 2004 waves are similar to
that in 1993; however, the percentage of the young baby boomers who were in the most
risk tolerant category was continuously decreasing from 23.04% in 1993 to 14.34% in
2004. The percentage of the young baby boomers who were in the least risk tolerant
104
category was the highest in 2002 (56.03%), followed by 2004 (53.96%) and 1993
(46.25%). In line with previous findings based on the SCF data (e.g. Sung & Hanna, 1996;
Rha, Montalto, & Hanna, 2006), the NLSY79 sample consistently shows that a
substantial proportion of the young baby boomers are not willing to take any risks.
Compared to those that used the HRS data (e.g. Sahm, 2007; Kimball et al., 2005; Barsky
et al., 1997), the patterns of distribution of risk tolerance are similar while a relatively
smaller proportion of the young baby boomers were classified as the least risk tolerant
and a larger proportion of them were classified as the most risk tolerant. In sum, most of
the young baby boomers were not willing to take any risks; however, they on the average
Notice that the objective measures of risk tolerance in 1979 and the survey-based
measures of risk tolerance in 1993, 2002, and 2004 are positively correlated (See Table
4.5), which means that the young boomers who were willing to take more risks or who
were more risk tolerant in the past will be classified into a more risk tolerant category in
the future. Furthermore, the correlations of measures of risk tolerance within methods are
105
Pearson Correlation Coefficients, n = 3,425
steal drug fighting criminc rt_93 rt_02 rt_04
steala 1.00000 0.43042 0.52102 0.50331 0.04783 0.06207 0.05037
<.0001 <.0001 <.0001 0.0051 0.0003 0.0032
drugb 1.00000 0.28596 0.40600 0.04802 0.04749 0.02981
<.0001 <.0001 0.0049 0.0054 0.0811
fightingc 1.00000 0.40475 0.02584 0.05874 0.03319
<.0001 0.1305 0.0006 0.0521
crimincd 1.00000 0.04398 0.04407 0.04077
0.0100 0.0099 0.0170
rt_93e 1.00000 0.20652 0.21475
<.0001 <.0001
rt_02f 1.00000 0.28102
<.0001
rt_04g 1.00000
Note: a Risk tolerance based on stealing-related activities in 1979; b Risk tolerance based
on drug use and sales in 1979; c Risk tolerance based on fighting and attacking people in
1979; d Risk tolerance based on earning criminal income in 1979; e Risk tolerance in
1993 (0: least risk tolerant; 3: most risk tolerant); f Risk tolerance in 2002; g Risk
tolerance in 2004.
The mean value of net worth in 2004 was $228,535 and its median value was
$96,500. The mean and median of net worth in 2000 were $158,724 and $58,650,
respectively. These figures are extremely smaller than those of business owners while
they are relatively larger when compared to those of non-business owners (e.g. Xiao et al.,
2001). In addition, the young boom generation had higher level of wealth compared to
general samples from the SCF data, regardless of gender and marital status (e.g.
Bajtelsmit et al., 1999; Jianakoplos & Bernasek, 1998). However, the young boomer
generation had lower level of mean wealth compared to older adults in terms of the HRS
106
data (e.g. Hariharan et al., 2000). The mean value of total family income of the young
baby boomers in 2003 was $72,266 and the median value was $58,613. Compared to
other groups of people, the young baby boomers had a lower family income level than
did business owners but a higher family income level than did non-business owners (Xiao
et al., 2001; Wang & Hanna, 2007). Additionally, the mean value of total family income
for the young baby boomers as a whole was smaller than that of Whites while it was
Preference Characteristics
The average age of the respondents in 2004 was 43.05, ranging from 39 to 48.
The proportion of females (50.92%) in 2004 was slightly larger than that of males
(49.08%), consistent with the gender distribution of the general baby boom population in
the U.S. In terms of race and ethnicity, roughly three-fifths (59.97%) of the young baby
boomers were non-Black, non-Hispanic Whites and others, 22.98% are Blacks, and
17.05% are Hispanics. As for earlier preference factors, around 12% were married and
10% had children in 1980. The mean value of the adjusted average AFQT score was
36.67 (s.d. = 28.78). The mean value of years of schooling of both father and mother of
the young baby boomers was roughly 11 years. The average number of siblings a
respondent had was 3.60 and the average year of schooling of the oldest sibling was
12.69 years. Compared to other groups of people in previous studies (e.g. Brown &
Taylor, 2006), the young boomers have on the average more siblings. In terms of 2004
preference characteristics, roughly 64% of the young baby boomer generation were
107
married and more than one-fifth (22.10%) of them were separated, divorced, or widowed.
8.41% of the young boomers reported that they were self-employed in 2004 and 91.59%
in literature (e.g. Gutter & Fontes, 2006). The average family size in 2004 was 3.16 and
more than two-thirds (67.77%) of the young boomers had children in household in 2004.
Both numbers were larger than those presented in previous studies (e.g. Gutter & Fontes,
2006; Bajtelsmit, 1999; Wang & Hanna, 2007), implying a heavier burden borne by the
young baby boomers compared to the general U.S. regarding taking care of their family
members. population. Surprisingly, merely 7.94 % of the young baby boomers have
received properties or money from any estates, trusts, inheritances, or gifts from relatives
Roughly 71% of the young boomers owned the home in which they lived, which is
comparable with other samples in literature (e.g. Jianakoplos & Bernasek, 1998; Gutter &
Fontes, 2006; Baek & DeVaney, 2004; Bajtelsmit et al., 1999). Roughly 10% of the
young baby boomers owned other property such as a second home or a time-share.
Control Variables
The descriptive statistics show that around 40% of the young baby boomers lived
in the South and merely 14% lived in the Northeast in 2004. The majority of the young
boomers lived in an SMSA (81.69%) in 2004. Roughly 94% of the young baby boomers
were born in the U.S. and 78% lived in an urban area at age 14.
108
CHAPTER 5
education and risky financial assets on multiple dimensions of individual well-being are
presented and discussed in this chapter. The chapter is divided into three sections. The
first section is the multivariate results for investment in education and investment in risky
financial assets. In the second and the third sections, the multivariate results for each
Table 5.1 shows the results of simultaneous equation models for risky investment
decisions in education and risky financial assets. Two models with different measures of
risky financial investment are presented and discussed. The first stage of estimating
109
Model I Model II
Years of Ratio of risky Years of Dollar
schooling financial assets schooling amounts of
to financial stocks in 2004
assets in 2004
(E) ( F1 ( Eˆ ) ) (E) ( ln F2 ( Eˆ ) )
Variables Coeff. Coeff. Coeff. Coeff.
Continued
Table 5.1 Results of Simultaneous Equations Models with Education Investment and
Risky Financial Investment
110
Table 5.1 Continued
Model I Model II
Years of Ratio of risky Years of Dollar
schooling financial assets schooling amounts of
to financial stocks in 2004
assets in 2004
(E) ( F1 ( Eˆ ) ) (E) ( ln F2 ( Eˆ ) )
Variables Coeff. Coeff. Coeff. Coeff.
Black 0.785*** -0.013 0.785*** -0.295
(0.090) (0.021) (0.090) (0.200)
Married in 1980 -0.768*** -0.768***
(0.116) (0.116)
Presence of children in 1980 -0.369*** -0.369***
(0.127) (0.127)
Individual ability 0.043*** 0.043***
(0.001) (0.001)
Education level of father 0.064*** 0.064***
(0.011) (0.011)
Education level of mother 0.065*** 0.065***
(0.015) (0.015)
Number of siblings of respondent -0.061*** -0.061***
(0.014) (0.014)
Education level of oldest sibling 0.093*** 0.093***
(0.009) (0.009)
Marital status in 2004
Never married -0.023 -0.141
(0.027) (0.268)
Separated, divorced, or widowed -0.026 -0.195
(0.023) (0.221)
Self-employed in 2004 0.039 0.349
(0.027) (0.265)
Presence of children in 2004 -0.020 -0.209
(0.023) (0.228)
Continued
111
Table 5.1 Continued
Model I Model II
Years of Ratio of risky Years of Dollar
schooling financial assets schooling amounts of
to financial stocks in 2004
assets in 2004
(E) ( F1 ( Eˆ ) ) (E) ( ln F2 ( Eˆ ) )
Variables Coeff. Coeff. Coeff. Coeff.
Family size in 2004 0.008 0.063
(0.008) (0.075)
Had inherited wealth in 2004 0.028 0.377
(0.029) (0.278)
Primary home owned in 2004 0.121*** 1.299***
(0.020) (0.196)
Secondary home owned in 2004 0.103*** 1.291***
(0.026) (0.253)
Control variables ( X E , X F , X WB )
In this section, the results for Model I, where investment in education was
captured by years of schooling and investment in risky financial assets was measured by
ratio of risky financial assets to financial assets in 2004, are presented and discussed.
The simultaneous equations estimates for years of schooling are reported in the
first column of Table 5.1. The F-test for the education equation has a p-value of less than
0.0001, indicating that the overall model for years of schooling is significant. The
explained by the predictor variables. Objective risk tolerance in 1979 and preference
characteristics (i.e., age, gender, race and ethnicity, marital status in 1980, presence of
children in 1980, individual ability (i.e., AFQT score), parental education, number of
siblings, and education level of the oldest sibling) are statistically significant predictors of
years of schooling at the level of 0.05 or less. A control variable indicating region of
An objective measure of risk tolerance which was derived from the 1979 illegal
activity participation was negatively associated with investment in education at the level
of less than 0.0001, suggesting that the young baby boomers who were less risk tolerant
as indicated by the drug use and sales domain of risk in 1979 had higher education
attainment. On average, if a young baby boomer’s objective risk tolerance under the drug
use and sales domain increased by one unit, his/her years of schooling decreased by
approximately 0.19 years, all else considered. In order to compare the explanatory
powers of risk tolerance derived using different methods and at different time points, this
113
study alternatively employed the 1993 survey-based measure of risk tolerance to predict
education investment of the young boomers.4 The reason that the survey-based measures
of risk tolerance in 2002 and 2004 were not included as predictor variables is because
individuals tend to invest in human capital in the form of education when young. Thus,
most of the young baby boomers might have finished their education at the time when
they were asked to answer the 2002 and 2004 hypothetical income risk questions.
Contrary to the hypothesis, the result showed that the 1993 survey-based measures of risk
tolerance were not significant predictors of education investment at the level of 0.05
without controlling for the 1979 objective measure of risk tolerance.5 The 1993 survey-
based measures of risk tolerance were also non-significant in the model where both
4
The simultaneous equations estimates results for years of schooling where risk tolerance
was captured by the 1993 survey-based measures and the 1993 survey-based measures as
well as the 1979 objective measures are presented in Table C.1 of Appendix C.
5
That the 1979 objective measures of risk tolerance had negative effects and the 1993
survey-based measure of risk tolerance had a positive effect on years of schooling may be
due to the timing of making education investment decisions and measuring individual
risk tolerance. People tend to invest in education when young; for this reason, the 1979
objective measures had significant negative effects on years of schooling assuming that
education investment is one type of insurance. As these people accumulate more skills
and knowledge via education, they may feel more comfortable taking risks, resulting in a
positive relationship between years of schooling and the 1993 survey-based measures.
Another explanation for the inconsistent results may be due to the relative risk associated
with education investment made in different life stages. Generally, a risk-averse young
baby boomer might prefer education to the labor market if he/she perceives the risk in the
labor market to be greater than continuing with his/her schooling. As one ages,
investment in education may become riskier because he/she has accumulated more
experiences and had higher wage rate in the labor market.
114
As documented in many studies, preference characteristics of individuals affected
level, older young boomers had higher education attainment than their younger
counterparts, which is in accord with Guiso and Paiella (2004). On average, a young baby
boomer’s years of schooling increased by roughly 0.11 years for each additional year of
age, other things being equal. Male young baby boomers were found to be less likely to
invest in education, with the years of schooling of males being 0.27 years fewer than
those of females. This result is consistent with Chen (2003) that females were more likely
to enroll in college. The gender-education relationship is also in accord with Belzil and
Leonardi (2007) that females had a lower probability of leaving school and with Kodde
(1986) that males had a lower probability of demanding additional education. The
estimated impact of race is that the years of schooling of Blacks and Hispanics were
roughly 0.79 years and 0.44 years, respectively, more than those of non-Black, non-
Hispanic Whites and others. The result is in accord with Chen, who noted that African-
Americans were more likely to invest in college education. Marital status when young
also played a role in predicting education investment, with the young boomers who were
married in 1980 having 0.77 years fewer of schooling than their single counterparts. The
young baby boomers who had children in 1980 also had 0.37 years fewer of schooling
than those who did not have any children at that time, implying additional time and
financial constraints faced by those with children. Individual ability evaluated in terms of
the AFQT score was significantly positively related to years of schooling, showing that
education level increased by roughly 0.04 years for each additional point on the AFQT
115
score. The AFQT score effect is even stronger than that in Chen’s study.
of all, there was a positive relationship between education level of the young boomers’
father and education level of the young boomers themselves. The positive relationship
held true for education level of the young boomers’ mother and that of the young
increased by about 0.064 years and 0.065 years, respectively, if years of schooling of
father and mother of these young baby boomers increased by one year. Both parental
education variables were significant with p-values less than 0.0001 and the direction of
the effects is in accordance with that in Chen (2003). In addition, education level of the
oldest sibling also had a positive effect on education attainment of the young boomers,
which means that if years of schooling of the oldest sibling increased by one year, years
of schooling of the young boomers increased by approximately 0.1 years. However, the
sibling decreased years of schooling of the young baby boomers by approximately 0.061
years, suggestive of money constraints of households. Last, the young baby boomers who
lived in the Northeast in 2004 had about 0.21 years fewer of schooling than their
Southern counterparts. The young baby boomers who lived in the North Central region in
2004 had 0.29 years fewer of schooling compared to their Southern counterparts.
It is important to note that the current study did not follow previous studies (e.g.
the model for predicting education investment. The reason of dropping these variables is
116
that the working status or occupations of parents are strongly associated with parental
education.
ratio of risky financial assets to financial assets are reported in the second column of
Table 5.1. The F-test for this model has a p-value of less than 0.0001, indicating that the
overall model is significant. The adjusted R2 suggests that roughly 16.7% of variation in
ratio of risky financial assets to financial assets is explained by the predictor variables.
The following variables are statistically significant at the 0.05 level or less: net worth in
2000, total family income in 2003, investment in education (i.e. years of schooling),
primary home ownership, secondary home ownership, and region of residence in 2004.
The young baby boomers’ objective indicators of risk tolerance were not
corporate bonds or government securities, and mutual funds at the 0.05 level. However,
the four objective measures in 1979 had discrepant effects in determining financial
investment in risky assets. First of all, less risk tolerant young baby boomers under the
drug use and sales domain and the earning criminal income domain held a larger
proportion of their financial assets in the form of risky assets. On the contrary, more risk
tolerant young baby boomers under the constructs of stealing and fighting and attacking
had a larger ratio of risky financial assets to financial assets. The inconsistent results as
well as the significant correlation coefficients between the four objective measures shown
in Table 4.5 may provide evidence for supporting Dohmen et al. (2005), who concluded
that the average willingness to take risk is different across domains, even though risk
117
parameters across domains are associated with one another. However, the evidence is
weak at best. The negative relationship between the objective measures of risk tolerance
and the ratio value may come from the fact that the young baby boomers are not willing
to takes risks in both earning income and investing in the financial market which affect
their income resources. It is also possible that the derived indices capture other personal
characteristics, rather than individual risk tolerance. The current study also included
financial assets to financial assets in 2004, with and without controlling for the 1979
objective measures of risk tolerance, for the purpose of comparison. Consistently, none of
the survey-based measures of risk tolerance in 1993, 2002, and 2004 were significant
predictors of risky financial investments in 2004, with and without controlling the 1979
objective measures, at the 0.05 level. Though surprising, the non-significant results may
be in line with Barsky et al. (1997), who argued that the relationship between risk
tolerance and risky financial asset holding is much weaker than theory suggests it should
be. The insignificant effect may also be due to the inclusion of the endogenously
Economic resources such as net worth in 2000 and total family income in 2003
had a positive effect on ratio of risky financial assets to financial assets in 2004, which is
in line with Gutter and Fontes (2006) and Barsky et al. (1997) that the amount of
held a larger proportion of risky financial assets, which is in accord with McInish et al.
(1993), Cohn et al. (1975), Hong et al. (2004), and Hariharan et al. (2000). The portfolio
118
proportion allocated to risky financial assets increased by 0.022 percentage points for one
unit increase in total family income, corresponding in direction to Zhong and Xiao (1995)
and Gutter et al. (1999). These positive relationships imply that risky financial assets are
normal goods, which is consistent with Deaton and Muellbauer (1980) and Arrow (1965).
of financial assets in risky financial assets at the less than 0.0001 level. Specifically, an
additional year increase in schooling increased ratio of risky financial assets to financial
assets by roughly 0.06, all else being equal. The positive relationship between risky
investment decisions in different domains is consistent with previous findings (e.g. Sahm,
2007; Gutter & Fontes, 2006; Kimball et al., 2005), suggesting that education attainment
leads an individual to accumulate more knowledge and skills and gain access to financial
markets. In addition, the educated young baby boomers are more capable of
understanding financial statements and may feel more comfortable calculating numbers.
proportion of financial assets invested in risky financial assets at the 0.05 level, except for
primary home ownership and secondary home ownership. The young boomers who
owned the home in which they lived in 2004 had higher ratios of risky financial assets to
financial assets than their counterparts who did not own a home in 2004. In addition, the
young baby boomers who owned a second home in 2004 had a larger proportion of
financial assets held in the form of stocks, corporate bonds or government securities, and
mutual funds in 2004, which is in accord with Gutter and Fontes (2006) and Jianakoplos
and Bernasek (1998). Specifically, the level of financial assets to risky financial assets of
119
the young boomers who owned the home in which they lived was roughly 0.12
percentage points higher than those who did not own their home. The risky financial
asset-to-financial asset ratio of the young baby boomers who owned a second home was
roughly 0.10 percentage points higher than those who did not own a second home. Both
results imply the importance of diversification to minimize the risk associated with
investment decisions.
financial asset ratio. Compared to those who resided in the South in 2004, the young baby
boomers who lived in the North Central region in 2004 held a larger share of risky
financial assets to financial assets in 2004. There was no significant difference between
the Northeasterners and the Southerners with respect to ratio of risky financial assets to
financial assets in 2004 at the 0.05 level. Similarly, the Westerners and the Southerners
were not significantly different in terms of proportion of financial assets that was
To summarize, one of the objective measures of risk tolerance and all of the
education attainment. On the other hand, net worth, total family income, education
investment, and home ownership were statistically significant factors that predict one’s
risky investment decisions in the financial market. The effects of these significant
predictors in the financial investment equation were so considerable that this set of
variables accounted for a relatively larger proportion of variation in the ratio of risky
financial assets to financial assets across the young baby boomers, leaving other factors
120
such as objective measures of risk tolerance (or survey-based measures of risk tolerance)
The results for Model II, where investment in education was captured by years of
schooling and investment in risky financial assets was measured by dollar amount
allocated to the stock market in 2004 (take natural logarithm transformation), are
The parameters and standard errors for years of schooling are presented in the
third column of Table 5.1. While the discussion is omitted, details can be found in sub-
section 5.1.1.1. The simultaneous equations estimates results for dollar amount of stocks
in the year of 2004 are reported in the fourth column of Table 5.1. The F-test for this
model has a p-value of less than 0.0001, indicating that the overall model is significant.
variables. The following variables are significant determinants of dollar amount of stocks
at the 0.05 level or less: net worth in 2000, total family income in 2003, years of
schooling, and preference characteristics such as primary home ownership and secondary
home ownership in 2004. The 2004 region of residence is also significant at the 0.05
level.
6
The simultaneous equations estimates for ratio of risky financial assets to financial
assets where risk tolerance was captured by the survey-based measures (See Table C.1 of
Appendix C) are consistent with those when risk tolerance was measured by the 1979
objective measures (See Table 5.1) in terms of significances and sign.
121
Risky financial investment captured by dollar amount allocated to stocks was not
significantly related to risk tolerance derived from the 1979 illegal activity participation,
consistent with the results in Model I. Similarly, the survey-based measures of risk
tolerance in 1993, 2002, and 2004 did not affect risky financial investments of the young
baby boomers when these measures replaced the objective measures of risk tolerance.
Non-significant results were also found in a model with both objective measures and
of risk tolerance accounted for ratio of risky financial assets to financial assets and dollar
amount of stocks across the young baby boomers, indicative of inappropriate measures of
risk tolerance or a trivial role of risk tolerance in predicting risky financial investments.7
dollar amount allocated to the stock market in 2004. First of all, net worth in 2000 had a
positive effect on dollar amount of stocks in 2004, even though the effect was relatively
small. Moreover, the income elasticity of dollar amount of stocks in 2004 with respect to
total family income in 2003 was approximately 0.22. These results suggest that the young
baby boomers who had more economic resources allocated a greater amount of these
economic resources in the stock market than their counterparts with fewer economic
resources, which are in line with the results found in Model I. The positive effects also
provide additional evidence that risky financial assets are normal goods.
7
The simultaneous equations estimates for dollar amount of stocks where risk tolerance
was captured by the survey-based measures in different years can be found in Table C.2
of Appendix C. Significant predictors are identical to those when risk tolerance was
measured by the 1979 objective measures in terms of signs and significances and can also
be found in Table C.2.
122
According to the theoretical model developed in the current study, portfolio
that was allocated to stocks in 2004 was significantly positively related to human capital
in the form of education at the less than 0.0001 level. On average, an additional year of
schooling increased the level of dollar amount of stocks by 66.2%. The positive effect of
education attainment on risky financial asset possession held true across models and the
effects were similar, regardless of how risky financial investments were defined.
was allocated to the stock market. First of all, the young boomers who owned the home in
which they lived in 2004 had a greater amount of money in the stock market in 2004.
Moreover, the young boomers who owned other property such as a second home or a
time-share allocated more of their money to the stock market in 2004. Specifically, the
effect of being a home owner was to change dollar amount of stocks by approximately
130%, regardless of the types of home ownership. These results are in accord with those
found in Model I where risky financial investment was captured by a ratio value. The
findings in both models consistently demonstrate the significant role of other types of
The 2004 dollar amount of stocks held by the young baby boomers was also
dependent on the young baby boomers’ region of residence in 2004. Specifically, dollar
amount that was allocated to the stock market was roughly 55% higher in the Northeast
and 49% higher in the North Central region than that in the South.
To sum up, the significant predictors of risky financial investments are similar,
123
despite the model specifications (Model I and Model II): net worth in 2000, total family
income in 2003, years of schooling, primary home ownership in 2004, secondary home
ownership in 2004, and region of residence in 2004. The only difference between Model I
dollar amount of stocks. Except for the education and region of residence variables, all of
the predictors are resource-related variables, suggesting that the young baby boomers
who possess more assets in either physical or non-physical form make more risky
financial investments than those who are short of economic resources. The positive effect
between economic resources and financial investments implies the possibility of creating
a larger gap between the rich and the poor, resulting in ever increasing wealth inequity.
being in Model I, where risky financial investment was all captured by ratio of risky
financial assets to financial assets, are presented and discussed in this section.
The simultaneous equations estimates for the 2006 current earned income (take
natural logarithm transformation) are shown in the first column of Table 5.2. The F-test
for this model has a p-value of less than 0.0001, indicating that the overall model is
explained by the predictor variables. The following variables are significant determinants
124
at the level of 0.05 or less: investment in education (i.e. years of schooling), investment
in risky financial assets (i.e. ratio of risky financial assets to financial assets), and
2004, and family size in 2004. None of the control variables are significant at the 0.05
level.
young baby boomers’ economic well-being with regard to current earned income in 2006.
On average, the level of current earned income in 2006 increased by roughly 28.3% for
each additional year of schooling. Analogous to years of schooling, the ratio of risky
financial assets to financial assets in 2004 was also a statistically significant factor in
predicting the young baby boomers’ well-being in economic dimension at the less than
0.0001 level. If the financial ratio increased by one point, the level of current earned
income in 2006 increased by about 245%. In short, risky investment decisions in different
125
Model I
Current Family PCS-12 Self- MCS-12
earned income in score in esteem in score in
income in 2006 2006 2006 2006
2006
ln WB1(Fˆ1) ln WB2 (Fˆ1) WB3 (Fˆ1) WB4 (Fˆ1) WB5 (Fˆ1)
Variables Coeff. Coeff. Coeff. Coeff. Coeff.
Net worth in 2004 ( W ) -5.22E-7 -1.04E-7 -2.25E-8
(6.12E-7) (3.465E-7) (6.279E-7)
Total family income in 2003 ( ln I ) 0.163 0.120* 0.267**
(0.109) (0.062) (0.112)
Continued
126
Table 5.2 Continued
Model I
Current Family PCS-12 Self- MCS-12
earned income in score in esteem in score in
income in 2006 2006 2006 2006
2006
ln WB1(Fˆ1) ln WB2 (Fˆ1) WB3 (Fˆ1) WB4 (Fˆ1) WB5 (Fˆ1)
Variables Coeff. Coeff. Coeff. Coeff. Coeff.
Separated, divorced, or widowed 0.053 -0.027 0.039 0.036 -1.453***
(0.176) (0.109) (0.404) (0.229) (0.414)
Self-employed in 2004 0.279 -0.124 0.563 0.488* 0.133
(0.215) (0.133) (0.477) (0.270) (0.490)
Presence of children in 2004 0.778*** 0.177 -0.168 0.248 -0.260
(0.184) (0.113) (0.405) (0.229) (0.415)
Family size in 2004 -0.356*** -0.094** 0.120 -0.160** -0.049
(0.060) (0.037) (0.133) (0.075) (0.136)
Control variables ( X E , X F , X WB )
Continued
127
Table 5.2 Continued
Model I
Current Family PCS-12 Self- MCS-12
earned income in score in esteem in score in
income in 2006 2006 2006 2006
2006
ln WB1(Fˆ1) ln WB2 (Fˆ1) WB3 (Fˆ1) WB4 (Fˆ1) WB5 (Fˆ1)
Variables Coeff. Coeff. Coeff. Coeff. Coeff.
Intercept 5.614*** 9.571*** 43.208*** 24.758*** 50.702***
(1.406) (0.872) (3.535) (2.001) (3.627)
Sample size = 3,425
Test of model fit F value: F value: F-value: F-value: F-value:
31.17 33.75 7.83 14.66 10.73
Pr>F: Pr>F: Pr>F: Pr>F: Pr>F:
<.0001 <.0001 <.0001 <.0001 <.0001
Adj. R2: Adj. R2: Adj. R2: Adj. R2: Adj. R2:
0.12357 0.13274 0.03465 0.06700 0.04865
*Significant at p<0.1; **Significant at p<0.05; ***Significant at p<.01.
Note: Standard errors are in the parentheses.
128
Among a series of preference characteristics included, gender was significant at
the 0.05 level, which means the 2006 current earned income was about 162% more for
males than for females, holding all other variables constant. The finding is in line with
common understanding of gender effects in the labor market. The young baby boomers
who were never married in 2004 had worse economic well-being than their married
counterparts because they had smaller current earned incomes in 2006. Specifically, the
effect of being never married was to change current earned income by roughly -48%.
Current earned income in 2006 was also associated with presence of children in 2004,
showing that the 2006 current earned income was roughly 78% higher for the young baby
boomers who had children in 2004 than for those who did not have any children at the
time. In terms of family size, an additional family member decreased the level of current
The simultaneous equations estimates for family income (take natural logarithm
transformation) are presented in the second column of Table 5.2. The F-test for this
model has a p-value of less than 0.0001, indicating that the overall model is significant.
The adjusted R2 is 0.13. Roughly 13% of variation in family income in 2006 is explained
by the predictor variables. Significant determinants of the 2006 family income at the 0.05
level or less include ratio of risky financial assets to financial assets and preference
characteristics, including race and ethnicity and family size. The 2004 region of residence
and country of birth are also significant predictors at the 0.05 level.
129
Analogous to the role that risky financial investment played in determining the
2006 current earned income, young baby boomers who allocated a larger proportion of
their financial assets to risky financial assets such as stocks, corporate bonds or
government securities, and mutual funds in 2004 had a larger family income in 2006,
implying that the 2004 risky financial investment promoted the young baby boomers’
economic well-being. Specifically, the level of family income increased by about 339%
when the financial ratio increased by one percentage point. The effect of ratio of risky
financial assets to financial assets on family income was even larger than that on current
earned income. Different from the significant effect of education attainment on the 2006
current earned income, years of schooling did not affect the 2006 family income at the
significance level of 0.05, even though the effect was consistently positive.
in 2006 are different from those determining current earned income in 2006. First of all,
compared to non-Black, non-Hispanic Whites and others, Black young baby boomers had
a smaller family income in 2006, showing that family income in 2006 was about 31.6%
lower for Blacks than for non-Black, non-Hispanic Whites and others. Variability in the
2006 family income, however, was not found between Hispanics and non-Black, non-
Hispanic Whites and others. Moreover, family size in 2004 was negatively associated
with family income in 2006, indicating that an additional family member decreased the
level of family income by approximately 9.4%. This negative result implies that the
young baby boomers from a larger family have to reallocate their time from labor market
130
Region of residence in 2004 was significant in predicting family income in 2006.
The young baby boomers who lived in the North Central region in 2004 had a smaller
family income in 2006 than their Southern counterparts. Specifically, family income in
2006 was roughly 26.3% lower in the North Central region than in the South. There was
no difference between the young baby boomers who lived in the Northeast and the young
baby boomers who lived in the South regarding the 2006 family income. Similarly, a
difference in the 2006 family income was not found between the Westerners and the
Southerners. In addition, the young baby boomers who were born in the U.S. had smaller
family incomes than those who were born in other countries. The effect of being born in
different indicators. First of all, years of schooling had a positive effect on current earned
income, but not on family income, at the significance level of 0.05. Second, gender (male)
played a positive role in determining current earned income, but not family income.
Moreover, marital status and presence of children affected current earned income, but not
family income. On the contrary, race and ethnicity affected family income, but not
current earned income. In terms of similarity, the risky financial asset-to-financial asset
ratio was positively related to both current earned income and family income in 2006.
The other similarity is that family size was negatively related to both indicators.
The simultaneous equations estimates for the 2006 Physical Component Summary
131
score (PCS-12) are presented in the third column of Table 5.2. The F-test for this
particular model has a p-value of less than 0.0001. Approximately 3% of variation in the
characteristic indicating whether the young baby boomer is male or female is significant
at the 0.05 level. A control variable that captured country of birth is also significant at the
0.05 level. The overall model is significant; however, economic resources such as net
worth and total family income, education investment (i.e. years of schooling), risky
financial investment (i.e. ratio of risky financial assets to financial assets), and most of
the preference factors are not significant predictors at the 0.05 level or less.
Statistically, economic indicators regarding net worth in 2004 and total family
income in 2003 failed to account for variability in the 2006 physical health among the
young baby boomers, implying that economic status was uncorrelated with physical
health status of the young baby boomers. Similarly, investment in education did not
significantly explain variation in physical health across the young baby boomers. The
insignificant effect of risky financial investment on the PCS-12 score provides additional
evidence that physical health status and socioeconomic status are uncorrelated.
The preference characteristic that was significant at the 0.05 level was gender.
Compared to their female counterparts, male young baby boomers had better physical
well-being in 2006. Specifically, the PCS-12 scores of males were 1.076 points higher
than those of females, holding all other variables constant. This result corresponds to
what was found in sub-section 5.2.1 that male young boomers had not only better
economic well-being but also better physical well-being than females. Consistent with the
132
negative effect of the country of birth variable on economic well-being, the young
boomers who were born in the U.S. had worse physical well-being than those who were
born in other countries. In other words, the PCS-12 scores of the young boomers who
were born in the U.S. were 1.22 points lower than those of the boomers who were born in
other countries.
while it was not associated with physical well-being. Risky financial investments had a
positive effect on economic well-being, but not on physical well-being, of the young
boomers. Most of the preference characteristics could explain disparity in current earned
income which was one of the indicators of economic well-being. However, the majority
of the preference characteristics included failed to account for the difference in physical
well-being and economic well-being which was captured by the 2006 family income.
5.2.4 Self-Esteem
For psychological well-being (i.e. self-esteem), the overall model has a p-value of
less than 0.0001. The adjusted R2 of this particular well-being model is 0.07; roughly 7%
education (i.e. years of schooling) and preference characteristics such as gender, race and
ethnicity, marital status, and family size are significant predictors of self-esteem in 2006
at the 0.05 level. Control variables does not account for disparity in self-esteem at the
Human capital in the form of education was significantly associated with the level
133
of self-esteem with a p-value less than 0.0001, indicating that the young baby boomers
who had more years of schooling had higher levels of self-esteem in 2006. On average,
the impact on the self-esteem score of an additional year of schooling was 0.39. The
effect of risky financial investments on self-esteem was not significant at the 0.05 level,
even though the sign of the effect was positive. Contrary to the insignificant effect of
In line with the results for current earned income in 2006, preference factors
accounted for a larger proportion of variation in self-esteem across the young boomers.
First of all, males had a higher self-esteem score than females in 2006. Specifically, the
self-esteem scores of males were approximately 0.51 points higher than those of females.
Second, Black young baby boomers had higher self-esteem than the young baby boomers
who were non-Black, non-Hispanic Whites and others. The estimated impact of race was
that the self-esteem scores of Blacks were about 1.01 points higher than those of non-
Black, non-Hispanic Whites and others. However, there was no difference between
Hispanics and non-Black, non-Hispanic Whites and others regarding the 2006 self-
esteem scores. The young baby boomers who were never married in 2004 had lower self-
were 0.57 points lower for never married young baby boomers than for married young
boomers. Last, the young baby boomers who had a larger family in 2004 had lower self-
134
esteem in 2006 compared to those who had a smaller family in 2004. On average, a
young baby boomer’s self-esteem score decreased by approximately 0.16 points for each
These results show that preference characteristics at individual and family levels
are significantly associated with self-esteem in 2006, which are different from physical
well-being that was predicted solely by individual characteristics. Altogether, none of the
economic indicators could explain variability in the PCS-12 score and the self-esteem
The F-test for this psychological well-being equation has a p-value of less than
variables. Total family income in 2003 and preference factors such as gender, race and
ethnicity, and marital status, are significant in predicting the 2006 MCS-12 score at the
0.05 level. Region of residence in 2004 is also significant at the 0.05 level.
Total family income was the only economic predictor that was significant at the
level of 0.05, showing that the young boomers who had a larger total family income in
2003 had better mental health status captured by the 2006 MCS-12 score. On average, if
a young baby boomer’s total family income increased by one percent, his/her MCS-12
score rose by approximately 0.0027 points. The effect of risky financial investment on
mental health was not statistically significant, although the sign of the effect was positive.
135
well-being across the young baby boomers, regardless of the measures of psychological
schooling were negatively related to mental health status, with the negative effect being
scores across the young baby boomers, except for age, self-employment status, presence
of children, and family size. First of all, male young baby boomers had higher MCS-12
scores in 2006 than their female counterparts, suggesting that males had better mental
health than their female counterparts. Compared to non-Black, non-Hispanic Whites and
others, Black young baby boomers had higher MCS-12 scores in 2006. Furthermore,
Hispanic young baby boomers had better mental health than the young baby boomers
who were non-Black, non-Hispanic Whites and others. The young baby boomers who
were never married in 2004 had lower MCS-12 scores in 2006 compared to their married
counterparts. Similarly, the young boomers who were separated, divorced, or widowed in
2004 had a smaller value of the 2006 MCS-12 score than their married counterparts.
Specifically, the MCS-12 scores of never married young boomers and the young baby
boomers who were separated, divorced, or widowed were 1.29 points and 1.45 points,
Region of residence was also a significant predictor of the 2006 MCS-12 score.
Compared to those who lived in the South, the young baby boomers who lived in the
West in 2004 had lower MCS-12 scores in 2006. The impact on the MCS-12 scores of
living in the West was -0.89 points. There was no difference between the Northeasterners
136
and the Southerners and between those living in the North Central region and those living
In sum, total family income was the only economic indicator that affected mental
the variation in mental health across the young baby boomers, with gender (male) being
the most important factor in terms of magnitude. Self-esteem and the MCS-12 score are
identical. First of all, total family income was a significant predictor of the MCS-12
score, but not self-esteem at the 0.05 level. Second, years of schooling were positively
related to self-esteem but not associated with the MCS-12 score at the significance level
of 0.05. Hispanics were different from non-Black, non-Hispanic Whites and others in
terms of the MCS-12 score while there was no difference between the two racial groups
in terms of self-esteem level. Marital status (being separated, divorced, or widowed) had
an insignificant positive effect on self-esteem; however, the effect became significant and
the sign turned into negative for mental health status of the young baby boomers.
Similarly, family size had a significant negative effect on self-esteem, but not on mental
health. Last, region of residence could explain disparity in mental health, but not self-
esteem.
137
well-being in Model II are presented and discussed in this section. Risky financial
amount of stocks.
The simultaneous equations estimates for the 2006 current earned income (with
natural logarithm transformation) are presented in the first column of Table 5.3. The F-
test for this model has a p-value of less than 0.0001. The adjusted R2 is 0.13, indicating
approximately 13% of variation in current earned income in 2006 was explained by the
stocks, and preference factors such as gender, race and ethnicity, marital status, presence
of children, and family size. None of the control variables were significant at the 0.05
level.
138
Model II
Current Family PCS-12 Self- MCS-12
earned income in score in esteem in score in
income in 2006 (ln) 2006 2006 2006
2006 (ln)
ln WB1(lnFˆ2) ln WB2(lnFˆ2) WB3(lnFˆ2 ) WB4 (lnFˆ2 ) WB5(lnFˆ2)
Variables Coeff. Coeff. Coeff. Coeff. Coeff.
Net worth in 2004 ( W ) -8.23E-7 -1.31E-7 -3.41E-7
(7.851E-7) (4.436E-7) (8.082E-7)
Total family income in 2003 ( ln I ) 0.174 0.134** 0.270**
(0.107) (0.060) (0.110)
Continued
Model II
Current Family PCS-12 Self- MCS-12
earned income in score in esteem in score in
income in 2006 (ln) 2006 2006 2006
2006 (ln)
ln WB1(lnFˆ2) ln WB2(lnFˆ2) WB3(lnFˆ2 ) WB4 (lnFˆ2 ) WB5(lnFˆ2)
Variables Coeff. Coeff. Coeff. Coeff. Coeff.
Separated, divorced, or widowed -0.084 -0.145 -0.019 -0.011 -1.490***
(0.168) (0.092) (0.393) (0.222) (0.405)
Self-employed in 2004 0.371* -0.052 0.611 0.519* 0.168
(0.209) (0.114) (0.471) (0.266) (0.485)
Presence of children in 2004 0.775*** 0.176* -0.170 0.245 -0.260
(0.178) (0.098) (0.402) (0.227) (0.414)
Family size in 2004 -0.346*** -0.084*** 0.132 -0.154** -0.039
(0.058) (0.032) (0.132) (0.074) (0.136)
Control variables ( X E , X F , X WB )
Continued
140
Table 5.3 Continued
Model II
Current Family PCS-12 Self- MCS-12
earned income in score in esteem in score in
income in 2006 (ln) 2006 2006 2006
2006 (ln)
ln WB1(lnFˆ2) ln WB2(lnFˆ2) WB3(lnFˆ2 ) WB4 (lnFˆ2 ) WB5(lnFˆ2)
Variables Coeff. Coeff. Coeff. Coeff. Coeff.
Intercept 4.380*** 8.802*** 43.097*** 24.375*** 50.814***
(1.355) (0.742) (3.537) (1.998) (3.641)
Sample size = 3,425
Test of model fit F value: F value: F-value: F-value: F-value:
31.84 42.93 7.92 14.87 10.81
Pr>F: Pr>F: Pr>F: Pr>F: Pr>F:
<.0001 <.0001 <.0001 <.0001 <.0001
Adj. R2: Adj. R2: Adj. R2: Adj. R2: Adj. R2:
0.12595 0.16383 0.03510 0.06795 0.04904
*Significant at p<0.1; **Significant at p<0.05; ***Significant at p<.01.
Note: Standard errors are in the parentheses.
141
Consistent with the results found in Model I, education investment had a positive
effect on the 2006 current earned income, suggesting that an additional year of schooling
increased the level of current earned income by approximately 40.3%. The effect of an
additional year of schooling on current earned income was even stronger in Model II
(40.3%) than in Model I (28.3%). Furthermore, dollar amount held in the stock market in
2004 had a positive effect on the 2006 current earned income, indicating that a young
baby boomer will have better economic well-being if he/she invests a greater amount of
his/her money in the form of stocks. Specifically, the elasticity of current earned income
with respect to dollar amount of stocks was approximately 0.09. Altogether, risky
earned income in 2006, no matter how risky financial investment was measured.
Analogous to the results found in Model I, current earned income in 2006 were
about 165% higher for males than for females. The effect of being Black was to decrease
current earned income by approximately 32.9%. The young baby boomers who were
never married in 2004 had a smaller value of current earned income than their married
counterparts in 2006. Specifically, current earned income was roughly 64% lower for
being never married, compared to that of being married. Having children in 2004 was
positively associated with the 2006 current earned income, which means that current
earned income was roughly 77.5% higher for the young baby boomers who had children
in 2004 than for those who did not have any children. In addition, the young baby
boomers who were from a larger family had a smaller current earned income in 2006. In
other words, an additional family member decreased the level of current earned income
142
by approximately 35%, which was quite close to the result in Model I.
Model I were also significant in Model II. The only difference in terms of preference
characteristics is the significant effect of race and ethnicity (being Black) on current
The F-test for family income (with natural logarithm transformation) has a p-
value of less than 0.0001. The adjusted R2 is 0.13, suggesting that approximately 13% of
variation in family income in 2006 is explained by the predictor variables. The following
variables are significant at the 0.05 level or less: years of schooling, dollar amount
allocated to the stock market, and preference characteristics (i.e. gender, race and
ethnicity, marital status, and family size). Region of residence and country of birth are
schooling had a positive effect on the 2006 family income, suggesting that more educated
young boomers had better economic well-being than less educated young boomers.
roughly 15.2%. As hypothesized, dollar amount allocated to the stock market in 2004
also had a positive effect on family income in 2006, indicating that a 1% increase in
dollar amount of stocks leaded to a 0.213% increase in the predicted family income.
143
All of the preference characteristics which were significant in Model I to predict
family income were also significant in Model II. First of all, Black young baby boomers
had a smaller family income than their non-Black, non-Hispanic Whites and others in
2006, with the effect of race being slightly stronger in Model II than in Model I.
Moreover, the young baby boomers from a larger family had lower family incomes. The
negative effect of family size was smaller in Model II (8.4% lower) when comparing to
that in Model I (9.4%). In addition to race and ethnicity and family size, the effect of
being never married was to decrease family income by roughly 35%. Furthermore,
gender was significant in predicting the 2006 family income, showing that the effect of
2004 played a role in predicting family income in 2006. The young boomers who lived in
the North Central region in 2004 had worse economic well-being than their Southern
counterparts. However, there are no differences between the Northeasterners and the
Southerners and between the Westerners and the Southerners regarding family income.
Country of birth consistently affected family income, which means that the effect of
being born in the U.S. was to decrease family income by approximately 31.4%.
The overall model for predicting the Physical Component Summary score (PCS-
12) is significant at the 0.0001 level; however, its adjusted R2 is 0.035, showing that
merely 3.5% of variation in the PCS-12 score is explained by the predictor variables. A
144
preference characteristic that indicates whether a young baby boomer is male or female
was significant at the 0.05 level. A control variable indicating country of birth was also
significant at the 0.05 level. First of all, the PCS-12 scores of males were 1.06 points
higher than those of their female counterparts. Moreover, the PCS-12 scores of the young
baby boomers who were born in the U.S. were approximately 1.20 points lower than
those of the young boomers who were born in other countries. These two variables were
also significant in Model I to predict PCS-12 score at the 0.05 level. In line with the
results shown in Model I, risky investments in different domains failed to account for
disparity in physical health across the young baby boomers. Similarly, economic
resources such as net worth and family income were not significant predictors across
model specifications. Notice that none of the preference characteristics at a family level
5.3.4 Self-Esteem
The F-test for self-esteem has a p-value of less than 0.0001, indicating that the
overall model is significant. The adjusted R2 is 0.067, suggesting that roughly 6.7% of
such as gender, race and ethnicity, marital status, and family size are significant at the
0.05 level, which are similar to those in Model I with respect to signs.
models, it is found that while total family income was not a significant determinant of
145
self-esteem in Model I, it accounted for disparity in self-esteem across the young baby
boomers in Model II, showing that the self-esteem scores rose by roughly 0.0013 points if
total family income measure increased by one percent. Education attainment was a
significant determinant of self-esteem in 2006 across models, with the effect of education
being stronger in Model II than in Model I. Namely, the impact on the self-esteem score
of an additional year of schooling was 0.42 points. The effect of risky financial
investments was non-significant in both models, even though the effect in each model
was positive. Moreover, net worth was not a significant predictor of self-esteem either in
predicting self-esteem were identical across models with respect to signs. Note that self-
employment status was significant at the 0.1 level. The impact on self-esteem scores of
being self-employed were 0.52 points higher than those of being employed by others.
The F-test for the model to predict the MCS-12 score has a p-value of less than
0.0001, indicating that the overall model is significant. The adjusted R2 for the model is
the predictors. Total family income in 2003 and a set of preference factors such as gender,
race and ethnicity, and marital status are significant at the level of 0.05. Region of
Consistent with the results in Model I for the MCS-12 score, total family income
in 2003 was significantly associated with the 2006 MCS-12 score in Model II, showing a
146
positive contribution of economic resources to psychological well-being. This positive
effect was slightly larger in Model II than in Model I. Analogous to the effect of net
worth in Model I, the 2004 net worth did not play a role in determining the MCS-12 score
in Model II at the significant level of 0.05. Neither education investment nor risky
financial investment affected mental health at the significant level of 0.05, which are in
line with the results found in Model I. In terms of preference characteristics, the
significant predictors were identical in Model I and Model II, but the magnitude of each
effect was different to some extent. First of all, gender (male) effect on the MCS-12 score
was larger in Model I than in Model II. Being Hispanic had a larger effect on the MCS-12
score in Model I while being Black had a stronger impact in Model II. Consistently, the
negative effects of marital status (being never married and being separated, divorced, or
Generally speaking, more risk tolerant young baby boomers invested less in
education than their less risk tolerant counterparts with regard to the 1979 objective
measure of risk tolerance under the drug use and sales domain. All of the preference
characteristics are significant to predict years of schooling at the 0.05 level. For example,
older young baby boomers had more years of schooling. Being female, being Hispanic,
and being Black were positively associated with years of schooling. These results
persons are more willing to make in order to get rid of poverty, which means education
147
investment is considered one type of insurance, rather than a risky investment. Being
married and having any children in 1980 were negatively associated with investment in
Individual ability evaluated by the AFQT score had a positive effect on education
investment, widening the gap between more intelligent young baby boomers and less
intelligent young baby boomers with respect to knowledge and skills. Parental education
and education level of the oldest sibling also had a positive effect on years of schooling.
However, the number of siblings was negatively related to years of schooling of the
was also a significant predictor, meaning that the young baby boomers living in the
Northeast and living in the North Central region had less years of schooling compared to
The predictors of risky financial investment are mainly consistent across models.
None of the risk tolerance measures were significant in predicting risky financial
investments at the 0.05 level. Economic resources such as net worth and total family
income were positively associated with ratio of risky financial assets to financial assets
and dollar amount of stocks, which indicates that risky financial assets are normal goods.
Years of schooling were positively related to the proportion of financial assets allocated
to risky financial assets and dollar amount allocated to stocks. Both primary home
ownership and secondary home ownership had positive impacts on the level of financial
assets allocated to risky financial assets and dollar amount in the stocks market,
indicating the importance of other types of assets in determining risky financial assets
148
such as stocks, corporate bonds or government securities, and mutual funds. Living in the
North Central region was positively associated with the proportion of financial assets
invested in risky financial assets and dollar amount allocated to the stock market. The
only difference between Model I and Model II is the Northeast-South disparity with
respect to dollar amount of stocks. To summarize, hypotheses H2a and H2b are not
models. Years of schooling had a positive effect on current earned income in both models
and a positive effect on family income merely in Model II. The proportion of risky
financial assets to financial assets and dollar amount of stocks were positively related to
current earned income and family income, respectively, showing that risky financial
investments had a positive effect on one’s economic well-being later in life. Preference
significant variables vary across models and indicators of economic well-being. Mainly,
Black young boomers had worse economic well-being than non-Black, non-Hispanic
Whites and others. Never married young baby boomers had worse economic well-being
than their married counterparts. Family size was negatively associated with economic
current earned income. Specifically, males had better economic well-being in Model II,
regardless of the indictors of economic well-being. In Model I, males merely had better
149
The predictors of physical well-being are identical between Model I and Model II
in terms of significances and signs. Most of the predictor variables such as economic
characteristics and risky investments were not significant. Gender and country of birth
were the only two variables which were significant at the 0.05 level. In sum, hypotheses
terms of well-being indicators and model specifications. Generally, total family income
both models; however, education attainment failed to account for discrepancy in mental
health in either Model I or Model II. Being male, being Black, and being married had a
positive effect on both self-esteem and the MCS-12 scores in both models. Being
Hispanic was positively related to the MCS-12 score in either model. Having smaller
family size was positively associated with self-esteem in Model I and Model II. In short,
150
Hypotheses Results
H1: Holding all other factors constant, risk tolerance has a significant effect on Partially supported
investment in education.
H2a: Holding all other factors constant, risk tolerance has a significant effect on Not supported
the proportion of liquid wealth invested in risky financial assets.
H2b: Holding all other factors constant, risk tolerance has a significant effect on Not supported
dollar amount of liquid wealth invested in risky financial assets.
H3a: Holding all other factors constant, investment in education has a significant Supported
effect on the proportion of liquid wealth invested in risky financial assets.
H3b: Holding all other factors constant, investment in education has a significant Supported
effect on dollar amount of liquid wealth invested in risky financial assets.
H4a: Holding all other factors constant, investment in education has a significant Partially supported
effect on economic well-being later in life.
H4b: Holding all other factors constant, investment in education has a significant Not supported
effect on physical well-being later in life.
H4c: Holding all other factors constant, investment in education has a significant Partially supported
effect on psychological well-being later in life.
H5a: Holding all other factors constant, investment in risky financial assets has a Supported
significant effect on economic well-being later in life.
H5b: Holding all other factors constant, investment in risky financial assets has a Not supported
significant effect on physical well-being later in life.
H5c: Holding all other factors constant, investment in risky financial assets has a Not supported
significant effect on psychological well-being later in life.
151
CHAPTER 6
Conclusions and implications of the current study are presented in this chapter.
The first section is the summary of statistical methods and key findings of the current
study. The second section is the implications of the current study. Limitations and
directions for future research are also discussed in the last section.
6.1 Conclusions
Financial investments with respect to risk have drawn substantial attention from
researchers in theory and in practice because individuals are taking more responsibility
for asset allocation of their portfolios due to the movement from defined benefit plans to
defined contribution plans. It is understood that risky financial investments are not made
in isolation while little research has attempted to incorporate decision making in different
domains within one theoretical framework. The main purpose of the current study is to
investigate the determinants of risky financial investments with one of the predictors,
tolerance. Multiple dimensions of individual well-being later in life are then examined
based on the two endogenously determined factors, including education investment and
152
risky financial investment. The data for the current study were from the 1979, 1980, 1981,
1993, 2000, 2002, 2004, and 2006 waves of the National Longitudinal Survey of Youth
1979. Variables from each wave were selected, making it possible to study causal
relationships among the variables. All of the young baby boomers in the sample had at
least some years of schooling and the median value of years of schooling was roughly 14
years. Approximately 47% of the young baby boomers owned risky financial assets.
Demand for risky assets and their respective impacts on individual well-being
were modeled in terms of the expected utility model and the Capital Asset Pricing Model
using simultaneous equations models. The decision to invest in oneself via education was
modeled as the first stage. The decision to make risky investments in the financial market
was then modeled, where the predicted value of years of schooling and the included
economic, physical, and psychological dimensions was then modeled with the predicted
values of years of schooling and ratio of risky financial assets to financial assets (or
dollar amount of stocks) and the included exogenous variables used as regressors.
Previous studies have assumed that there is a single, underlying risk attitude that
governs risk-taking behavior in all domains of life in economics. For this reason, risk
attitude derived from actual risk-taking behavior or hypothetical income risk questions is
considered an indicator of risk tolerance in all other contexts. Based on that rationale, this
education and risky financial assets. The results show that the risk tolerance variable in
1979 had a significant negative effect on education investment (i.e. years of schooling),
153
indicative that the young baby boomer generation tends to view education investment as
one type of insurance or that the marginal risk associated with education investment is
small, in line with Belzil and Leonardi’s (2007) conclusions using the Italian data. The
results also suggest that the young baby boomers who were not willing to participate in
illegal activities make investments in education because their average willingness to take
risk varies across domains, which is in accordance with Dohmen et al. (2005). Scholars in
various disciplines such as psychology and economics have questioned the existence of
stable utility functions and risk attitude, given that attitude toward risk seems to be
dependent on the context provided in laboratory experiments (Dohmen et al., 2005). Even
though individuals have stable risk preferences, it is likely that they consider the typical
risk in one context more than in another. The current finding does provide additional
imply that the young baby boomers hold risky financial assets because they have taken
more responsibility for selecting the types of investment instruments that involve
different levels of risk due to the movement toward defined contribution retirement plans,
rather than because they have propensity to tolerate risks. Another potential explanation
might be that the effect of investment in education is so substantial that decision making
of the young baby boomers is mainly driven by the relevant knowledge and skills they
accumulated from education investment, rather than by their innate risk tolerance. It is
also possible that the objective measures of risk tolerance which are derived based on
illegal activity participation are not a good proxy for pure risk preference because the
154
created indices merely reflect other personal characteristics such as entrepreneurial ability
and a preference for autonomy, rather than one’s risk tolerance. Last, the wording of the
hypothetical income risk questions in the NLSY79 may make the young baby boomers
have an aversion to a new job irrelevant to its income risk. Following Barsky et al. (1997),
can make choices between two new jobs, rather than between a current, certain job and a
has a positive effect on the proportion of risky financial assets to financial assets and the
dollar amount allocated to the stock market, suggesting that the young baby boomers who
have more years of schooling are more capable of collecting financial information,
understanding technical terms, and calculating numbers than those who have fewer years
of schooling; therefore, they may feel more comfortable or confident taking risks via
allocating a larger proportion of their financial assets to risky financial assets or holding a
greater amount of their money in the stock market. This significant positive effect of
financial investments, leaving risk tolerance and most of the preference characteristics
rather trivial in predicting either the ratio of risky financial assets to financial assets or the
results show that investment in education positively affects economic well-being and
155
psychological well-being in terms of self-esteem; however, it fails to account for
health across the young baby boomers. Risky financial investment consistently has a
positive effect on economic well-being while it does not significantly affect well-being in
physical and psychological dimensions. The diverse effects of risky investments across
In other words, a common single factor has its limitation on predicting one’s overall well-
being level. Schooling enhances an individual’s productivity, and, in turn, wage paid in
the labor market (Bryant & Zick, 2006), resulting in better economic well-being captured
by current earned income and family income. Bryant and Zick also argued that education
has been regarded as a signal of ability or productivity. Employers who have the belief
that education is associated with productivity will screen employees for their education
and pay higher wage rates to the more educated ones (Chevalier, Harmon, Walker, &
Zhu, 2004). On the other hand, individuals who take financial risks are compensated by
the opportunity of realizing a higher return. The compensations for taking risks are then
across individuals, leaving risky investments rather trivial in predicting physical well-
being. Last, students who go to school learn a body of knowledge and consequently have
higher self-esteem because they believe they are more capable, satisfied and proud than
the less educated. Note that well-being in one specific dimension can be captured by
156
multiple indicators. For example, both mental health and self-esteem are indicators of
health, goodness, appearance, and social competence. Even though the two indicators are
found to be associated with each other, individuals are very likely to response differently
to these two different types of assessment instruments, generating discrepant results for
psychological well-being.
being are more complex than expected; for this reason, a comprehensive model is
definitely needed to portray a more complete picture of risk-taking behavior, including its
6.2 Implications
The current study makes several contributions to existing literature. First of all,
this study has theoretical implications. Consistent with Dohmen et al., (2005), the
findings of insignificant effects of risk tolerance provide evidence for the limited ability
of an economic theory based on its strict assumption that a single, underlying risk
behavior in different domains. These findings also suggest that risk tolerance may vary
across domains, which means that an individual may consider the typical risk in one
context more than in another, in line with previous argument of unstable attitude toward
157
risk of individuals. Last, the elicited risk responses to hypothetical choices and the
objective measures of risk tolerance may not perfectly connect risk-taking behavior in the
real world, resulting in an insignificant relationship between risk tolerance and risky
These findings also suggest that the original Capital Asset Pricing Model (CAPM)
partially explains the demand for risky financial investment. However, this does not
imply that the application of the CAPM to understanding demand for risky financial
assets is of little value. Deviations from the CAPM may provide valuable information for
augmenting the model in finance. First of all, the original CAPM with a series of strict
assumptions that reduce the complex situation to an extreme case may fail to account for
the disparity in investment decisions among individuals. For this reason, the release of
key assumptions extends the explanatory power of the CAPM. For example, the current
study indicates that preference characteristics such as home ownership influence the
demand for risky financial assets, consistent with previous studies which have also
illustrated that holding other types of assets affect the demand for risky financial assets.
As a result, identifying and including such variables in the CAPM can explain additional
variance in demand for risky financial assets. Furthermore, the current finding implies
that a non-zero hk ,m does exist because human capital is significantly associated with
human capital assets surpass risk tolerance in predicting investment in the financial
market, suggesting the existence of non-marketable human capital and the inclusion of
158
human capital in modeling individual portfolio composition.
The advance of medicine has prolonged one’s life, leading people spending a
larger proportion of life in retirement. Sufficient pension and retirement income to cover
a longer time period are therefore needed to supplement individual needs. Better physical
and mental health is also indispensable to meet the demands of everyday life.
building their wealth and health at an earlier stage of life can achieve a higher level of
well-being later in life. The conclusions in this study have important implications for
The empirical finding that the 1979 illegal activity participation was negatively
associated with education investment suggests that individuals who have participated in
illegal activities such as drug use and sales tended to under-invest in education.
Comparing to other predictors of education investment, the risk tolerance variable does
capital such as parental education and education of the oldest sibling and other preference
characteristics, on the contrary, play a substantially larger role. To begin with, the
more than one generation benefit from human capital investment. Second, that education
159
level of an individual increases with that of his/her own siblings provides additional
evidence that benefits from education investment can spread not only from generation to
generation but within generations. In addition to family human capital, individuals who
receiving education is a means to get rid of poverty or one type of insurance against
uncertainty. Last, education investment involves the use of scarce resources, including
money and time, implying the expensive attribute of education investment in terms of
Seeing that individuals might change their attitudes, values, or behavior in order
to conform to the peer group they belong to due to peer pressure, which is particularly
common because most youths are forced to spend large amount of time in fixed groups
such as schools and sub-groups within schools, the negative relationship found between
developing educational programs that encourage this group of people who have
participated in illegal activities to receive more education. This type of policies not only
increases the average education level of the U.S. citizens but also has a positive effect on
risky financial investment in later stage of life, resulting in better economic well-being
has been found to reduce schooling enrollment rates (e.g. Flug, Spilimbergo, &
Wachtenheim, 1998), and, in turn, aggravate income inequality. For this reason, long-
term, stable funding such as Federal student aid programs and state aid programs is
160
necessary, particularly during the period of economic recession, because education
investment is a cumulative process that takes time as well as money. According to the
U.S. Department of Education, the Federal programs provide more than $80 billion per
year in grants, loans, and work-study assistance, helping students or parents pay for their
or their children’s school.8 State aid programs also provide a variety of grant and
scholarship programs to aid students as they pursue education. In view of the severe
economic downturn in the U.S., educational authorities may consider loosen the
In addition to financial aid programs, transfer and tax policies have their
education subsidy programs are needed for students, particularly for those are from
households in poverty or with limited economic resources and those from households
with a larger family size in terms of the presence of children under age 18 or the number
of siblings. The inclusions of expanded student loan interest deduction, tuition and fees
deduction, and education credits in the federal income tax system and corresponding
mechanism in the state tax system would alleviate the tax burden of households,
education.
8
Available at: http://studentaid.ed.gov/PORTALSWebApp/students/english/funding.jsp
161
Disparity in the number of years of schooling does exist among individuals who
state, and local government levels may be essential for boosting enrollment rates in
school in particular areas. As mentioned before, the cost of education, including tuition
and fees and expenditures on room, board, and travel, is substantial; thus, more accessible
education resources provided for residents in each state might encourage local students to
schedules or policies that provide services such as short-term child care are desirable
because these programs or polices facilitate students to manage their time as well as their
money in a more efficient way, particularly for those who have to take care of their
elderly parents and raise their young children, providing them with more choices of
receiving education.
particularly for potential investors in human capital market, and, in turn, stimulate
psychological dimensions.
economic dimension. People who have more years of schooling may feel more confident
162
or capable of investing in the financial market because they have accumulated more
financial knowledge and skills to improve their financial decision making than their
counterparts. For this reason, financial service professionals should provides appropriate
guidance to meet the financial goals of their clients based on individual educational
background. Financial service professionals may also provide financial education for
investors, particularly for those who have a lower education level, making these investors
equipped with relevant financial knowledge and skills and feel comfortable when making
risky financial investments. For potential investors, financial service professionals can
offer free investment seminars or lectures to explain basic concepts of investment terms
Since the empirical results show that individuals with fewer economic resources
invested less in risky financial assets, and in turn, negatively affected their economic
well-being, financial service professionals should pay greater attention to their clients
who have smaller amount of net worth and/or total family income. The reallocation from
relatively risk-free assets to risky assets may help this group of investors to accumulate
their wealth increasingly, narrowing the gap between the rich and the poor with respect to
economic well-being later in life and lightening the burden borne by future generations.
diversification (Wang & Hanna, 2007) that helps minimize the risk from any investment;
therefore, home owners are more likely to possess stocks or other types of risky financial
163
financial investment, financial service professionals need to take into consideration the
Wang and Hanna (1997) and Bajtelsmit et al. (1999) have argued that real estate
other than an owner-occupied home is one type of risky financial assets. In line with this
rationale, clients who have a second home may have different preferences or propensities
to risky financial investments. Even though the empirical findings in this study show that
objective measures of risk tolerance and risk tolerance derived from a set of hypothetical
income risk questions do not have significant effects on risky financial investments, this
does not necessarily mean that risk tolerance is not important for predicting risk-taking
behavior in the financial market. Since risk tolerance may change with age or context
tolerance measures for financial services practitioners to examine how their clients
tolerate risk with respect to financial investments. Financial service practitioners may be
able to accurately detect clients’ risk tolerance level and then provide suitable investment
resources of risk tolerance measures. Assuming that owning a second home is risky is
true, financial planning and education should encourage individuals who are classified as
less risk tolerant and consequently avoid holding high return assets such as stocks to
allocate part of their investments to broadly diversified stock funds in order to maintain
164
come from the fact that the proxies for risk tolerance in this study did not fully capture
risk tolerance but other personal characteristics. For this reason, financial service
capture risk tolerance of their clients. Following the findings that risk tolerance is not
stable and may changes with age or other demographic characteristics and depends on the
need to track and measure risk tolerance of their clients regularly to provide appropriate
Risk tolerance may jointly determine education investment and risky financial
investment while little research has been conducted to model both risky investment
decisions simultaneously within one theoretical framework. The current study may be the
first known study that employs simultaneous equations models to account for joint
investment decisions in different domains and/or at different life stages based on the
Capital Asset Pricing Model. The reason for using simultaneous equations models instead
of one single equation OLS regression analysis is that the assumption that all explanatory
variables are uncorrelated with the error term is violated because investment in education
that this analytical approach has the ability to detect indirect effects coming from casual
relationships among the factors included. For example, the empirical findings based on
165
simultaneous equations estimates suggest that risk tolerance has a significantly stronger
effect on education investment made when young and the accumulated knowledge and
skills from education in turn affect investment decisions in the financial market, leaving
different from previous studies that simply used OLS regression analysis (e.g. Guiso &
Paiella, 2004; Kimball et al., 2005; Gutter & Fontes, 2006; Sahm, 2007). That “the
relationship between risk tolerance and the holding of risky assets is much weaker than
theory suggests it should be (Barsky et al., 1997)” may be explained in terms of the
equations, this particular statistical method can be applied to study diverse investment
decisions in the financial market. In view of the serious problem of the housing crash in
the U.S., future research is encouraged to examine how investment in real estate and
investment in the stock market inter-relate to each other in the real world. The inter-
relationship between risky financial assets with respect to different level of risks can be
and risky financial assets are jointly determined while well-being in different dimensions
is examined separately. The reason for doing so is dependent on the purpose of the
current study to explore the causal relationship between risk tolerance, risk-taking
more comprehensive picture of individual well-being since current earned income alone,
166
for example, cannot account for the overall well-being of an individual. Previous
researchers have argued about the relationship between economic status and health status
economic status affects health status or the opposite. Future study can take advantage of
simultaneous equations models to detect the causal relationship with multiple measures
Although these empirical findings are robust, there are several limitations of the
current study. First of all, to protect the confidentiality of respondents, the NLSY79
allows top-coding the extremely high values of wealth data provided by respondents by
replacing all values above the cutoff values with the average of all outliers (Zagorsky,
1999). Top-coding masks the values provided by the rich who are the very persons in that
researchers are particularly interested. The increasing number of top coded individuals
with time also implies that the data is less usable for future research. Second, status quo
bias of the NLSY79 hypothetical income risk questions is problematic because the
wording may make individuals have an aversion to a new job irrelevant to its income
risk. Some respondents may answer these questions without understanding the meanings
of the questions or value their jobs based on reasons other than an economic or financial
one and hesitate to leave their job despite the large expected increase in income. It is also
reality. Another limitation of this study is that the 1979 illegal activity participation may
capture other personal characteristics, rather than risk tolerance, leading to inconsistent
results with those in previous results. For this reason, other nationally representative
167
surveys with both wealth information and information for deriving risk tolerance are
actual risk-taking behavior in different domains may be an option for creating indices of
risk tolerance. Examples are smoking behavior, drinking behavior, substance use, sexual
activity, and so forth. Last, the 2006 wave of the NLSY did not collect wealth
information of its respondents; for this reason, wealth data or more comprehensive
are not available for the current study. Similarly, direct measures of psychological well-
168
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184
APPENDIX A
185
Item Description Scale
1 I feel that I'm a person of worth, at least on equal basis with others. 1: Strongly agree
2: Agree
2 I feel that I have a number of good qualities. 3: Disagree
4: Strongly disagree
3 All in all, I am inclined to feel that I am a failure.
186
APPENDIX B
187
Description Scales Categories
1 Purposely damaged or destroyed property that did not belong to 0: None Stealing
you? 1: Once
2 Gotten into a physical fight at school or work? 2: Twice Fighting and
3: 3-5 times attacking
3 Taken something from a store without paying for it? 4: 6-10 times Stealing
5: 11-50
4 Other than from a store, taken something not belonging to you times Stealing
worth under $50? 6: > 50 times
5 Other than from a store, taken something not belonging to you (The 2nd and Stealing
worth $50 or more? 3rd categories
6 Used force or strong arm methods to get money or things from a being Criminal
person? combined, income
7 Hit or seriously threatened to hit someone? resulting in 6 Fighting and
categories attacking
8 Attacked someone with the idea of seriously hurting or killing ranging from Fighting and
them? 0 to 5) attacking
9 Smoked marijuana or hashish (“POT,” ”Grass,” “Hash”)? Drug use and
sales
10 Used any drugs or chemicals to get high or for kicks, except Drug use and
marijuana? sales
11 Sold marijuana or hashish? Drug use and
sales
12 Sold hard drugs such as heroin, cocaine, or LSD (total # of all Criminal
hard drug sales)? income
13 Tried to get something by lying to a person about what you Fighting and
would do for him, that is, tried to con someone? attacking
14 Taken a vehicle for a ride or drive without the owner’s Stealing
permission?
15 Broken into a building or vehicle to steal something or just to Stealing
look around?
16 Knowingly sold or held stolen goods? Stealing
188
APPENDIX C
189
(1) (2)
Years of Ratio of risky Years of Ratio of risky
schooling financial schooling financial
assets to assets to
financial financial
assets in 2004 assets in 2004
Variables Coeff. Coeff. Coeff. Coeff.
Objective risk tolerance in 1979
Stealing 0.004 0.038
(0.116) (0.028)
Drug use and sales -0.192*** -0.013
(0.036) (0.009)
Fighting and attacking -0.138* 0.012
(0.074) (0.018)
Earning criminal income -0.175 -0.014
(0.143) (0.034)
Survey-based risk tolerance in 1993
Most risk tolerant 0.118 -0.029 0.147* -0.028
(0.081) (0.020) (0.081) (0.020)
Moderately risk tolerant 0.022 -0.031 0.020 -0.032
(0.089) (0.021) (0.088) (0.021)
Weakly risk tolerant 0.144 -0.038 0.142 -0.038
(0.099) (0.024) (0.098) (0.024)
Survey-based risk tolerance in 2002
Most risk tolerant 0.008 0.006
(0.022) (0.022)
Moderately risk tolerant -0.019 -0.018
(0.022) (0.022)
Weakly risk tolerant 0.011 0.011
(0.025) (0.025)
Continued
Table C.1. Results of Simultaneous Equations Models for Years of Schooling and Ratio
of Risky Financial Assets to Financial Assets
190
Table C. 1. Continued
(1) (2)
Years of Ratio of risky Years of Ratio of risky
schooling financial schooling financial
assets to assets to
financial financial
assets in 2004 assets in 2004
Variables Coeff. Coeff. Coeff. Coeff.
Survey-based risk tolerance in 2004
Most risk tolerant 0.025 0.024
(0.023) (0.023)
Moderately risk tolerant 0.039* 0.040*
(0.023) (0.023)
Weakly risk tolerant 0.005 0.005
(0.021) (0.021)
Continued
191
Table C. 1. Continued
(1) (2)
Years of Ratio of risky Years of Ratio of risky
schooling financial schooling financial
assets to assets to
financial financial
assets in 2004 assets in 2004
Variables Coeff. Coeff. Coeff. Coeff.
Married in 1980 -0.738*** -0.770***
(0.116) (0.116)
Presence of children in 1980 -0.366*** -0.365***
(0.128) (0.127)
Individual ability 0.043*** 0.043***
(0.001) (0.001)
Education level of father 0.062*** 0.065***
(0.011) (0.015)
Education level of mother 0.059*** 0.063***
(0.015) (0.011)
Number of siblings of respondent -0.064*** -0.062***
(0.014) (0.014)
Education level of oldest sibling 0.094*** 0.092***
(0.010) (0.009)
Marital status in 2004
Never married -0.021 -0.021
(0.028) (0.028)
Separated, divorced, or widowed -0.028 -0.026
(0.023) (0.023)
Self-employed in 2004 0.037 0.039
(0.027) (0.027)
Presence of children in 2004 -0.020 -0.019
(0.023) (0.023)
Family size in 2004 0.008 0.008
(0.008) (0.008)
Continued
192
Table C. 1. Continued
(1) (2)
Years of Ratio of risky Years of Ratio of risky
schooling financial schooling financial
assets to assets to
financial financial
assets in 2004 assets in 2004
Variables Coeff. Coeff. Coeff. Coeff.
Had inherited wealth in 2004 0.030 0.028
(0.029) (0.029)
Primary home owned in 2004 0.119*** 0.121***
(0.020) (0.020)
Secondary home owned in 2004 0.102*** 0.102***
(0.026) (0.026)
Control variables ( X E , X F , X WB )
193
(1) (2)
Dollar amount of stocks in Dollar amount of stocks in
2004 (ln) 2004 (ln)
Variables Coeff. Coeff.
Objective risk tolerance in 1979
Stealing 0.391
(0.270)
Drug use and sales -0.149*
(0.083)
Fighting and attacking 0.197
(0.172)
Earning criminal income -0.006
(0.332)
Survey-based risk tolerance in 1993
Most risk tolerant -0.266 -0.254
(0.194) (0.194)
Moderately risk tolerant -0.381* -0.385*
(0.208) (0.208)
Weakly risk tolerant -0.247 -0.253
(0.231) (0.231)
Survey-based risk tolerance in 2002
Most risk tolerant -0.018 -0.034
(0.215) (0.216)
Moderately risk tolerant -0.310 -0.305
(0.210) (0.211)
Weakly risk tolerant 0.130 0.133
(0.243) (0.243)
Survey-based risk tolerance in 2004
Most risk tolerant 0.219 0.210
(0.228) (0.228)
Continued
Table C.2. Results of Simultaneous Equations Models for Dollar Amount of Stocks
194
Table C. 2. Continued
(1) (2)
Dollar amount of stocks in Dollar amount of stocks in
2004 (ln) 2004 (ln)
Variables Coeff. Coeff.
Moderately risk tolerant 0.378* 0.386*
(0.222) (0.223)
Weakly risk tolerant 0.141 0.139
(0.205) (0.205)
Continued
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Table C. 2. Continued
(1) (2)
Dollar amount of stocks in Dollar amount of stocks in
2004 (ln) 2004 (ln)
Variables Coeff. Coeff.
Self-employed in 2004 0.335 0.353
(0.266) (0.266)
Family size in 2004 0.065 0.062
(0.075) (0.075)
Had inherited wealth in 2004 0.406 0.391
(0.278) (0.278)
Primary home owned in 2004 1.271*** 1.287***
(0.197) (0.198)
Secondary home owned in 2004 1.287*** 1.286***
(0.254) (0.254)
Control variables ( X E , X F ,
X WB )
Region of residence in 2004
Northeast 0.554** 0.555**
(0.232) (0.233)
North Central 0.503*** 0.494***
(0.188) (0.189)
West -0.027 -0.006
(0.212) (0.213)
Intercept -9.206*** -10.225***
(1.649) (1.698)
Sample size = 3,425
Test of model fit F value: F-value:
37.97 33.44
Pr>F: Pr>F:
<.0001 <.0001
Adj. R2: Adj. R2:
0.22573 0.22703
*Significant at p<0.1; **Significant at p<0.05; ***Significant at p<.01.
Note: Standard errors are in the parentheses.
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