Revisiting the composition puzzles of the household portfolio: New evidence

Abstract This paper presents new evidence which contradicts the existence of the portfolio composition puzzles concerning household finance: portfolio risk increases empirically with age and wealth which contradicts Merton's (1971) solution. The puzzles cause serious problems when assessing the classical theoretical models that have been developed to rationalize households' portfolio choices. This paper investigates the 2005 Panel Study of Income Dynamics (PSID) data and shows that, when the household portfolio includes real estate and private business and allows for leverage, the portfolio risk for young and low‐wealth households is in general higher than that in older and richer households, which is consistent with the predictions of classical models.