Question

• Table 1 shows regressions of Swedish household portfolios’ beta for different brackets of the distribution of net wealth between 1999 and 2007 (standard errors are not reported). The table can be read as follows: if we distribute the households according to their net wealth from the less wealthy to the more wealthy ones, those, for example, that lie between 50% and 55% of the distribution (that is, they are more wealthy than the lower 50% but less wealthy than the top 45%) hold portfolios with average beta 0.748 (the first row in the table). How would you interpret the results? Could risk exposure be a factor explaining the wealth inequality? Explain your answer.

Table 1 Swedish household portfolios’ beta coefficients for different net wealth distribution percentiles

Percentiles	Beta coefficient
50–55	0.748
55–60	0.753
60–65	0.756
65–70	0.759
70–75	0.762
75–80	0.767
80–85	0.774
85–90	0.785
90–95	0.802
95–97.5	0.823
97–5-99	0.841
99–99.9	0.876
100	0.912

Answer 1

As per the given table we can see that the Beta coefficient is increasing as we go down the table and increasing the percentile numbers. For example if we see the Percentiles 55-60 and 65-70 and their corresponding beta’s that are 0.753 and 0.759 we see households which are wealthier than lower 65% and less wealthy than top 70% incur more risk than those of percentile 55-60%. Prima facie view of the table leads to the interpretation that higher the risk taken by the households more is the wealth generation and inequality in wealth among households.

Considering the above paragraph risk exposure may be a factor that explains wealth inequality. Some households may earn high average returns due to high investment skill or risk tolerance, a channel often referred to as type dependence. Financial risk is positively related to net worth. Wealthy households invest aggressively in risky assets and achieve high expected returns on financial wealth while investment skill seems to play no significant role in this investment.

However risk exposure may not be the only factor. Another channel called scale dependence, considers that households with high net worth earn high average returns, because they have access to better information or investment opportunities than others or they exhibit decreasing relative risk aversion. Over time, high-type households are likely to join the highest parts of the distribution, which may cyclical effect of returns being invested again and again due to better knowledge and investment opportunities and result in accumulation of wealth. If returns vary across households, inequalities in wealth should widen over time.

In the given question, increasing beta puts the household in wealthier percentiles. Household assuming greater risk get higher variance in returns than those who are risk averse and assuming low risk and accumulate wealth. Hence, from the above discussion we come to the conclusion that risk exposure and heterogeneity in returns due to better information about investments and investments opportunities are the drivers of wealth inequality. But, differences in investment skill or information do not seem to be first-order contributors to wealth inequality but contributes yo it in a large extent. Risk exposure seems to be the major driver. This is also proved by the table given in the question.