Using proprietary financial data on millions of households, we show that (likely) Republicans increased the equity share and market beta of their portfolios following the 2016 presidential election, while (likely) Democrats rebalanced into safe assets. We provide evidence that this behavior was driven by investors interpreting public information using different models of the world by using detailed controls to rule out the main non-belief-based channels like income hedging needs, preferences, and local economic exposures. These findings are driven by a small share of investors making big changes, and are stronger among investors who trade more ex ante.

Using data on the portfolios and income of millions of U.S. retirement investors, I find that positive and persistent shocks to income lead to a significant increase in the portfolio equity share, while increases in financial wealth due to realized returns lead to a small decline. The positive net effect in the data is evidence for risk aversion that decreases in total wealth. I estimate a portfolio choice model that matches the reduced-form estimates with a significant degree of non-homotheticity in risk preferences. Decreasing relative risk aversion preferences significantly increase the share of wealth at the top of the distribution.

Households are subject to substantial tail risk in individual labor income, and the amount of income risk fluctuates over the business cycle. This paper proposes a New Keynesian production-based asset pricing model where idiosyncratic labor income risk is a key source of priced risk in equity markets. Uninsured income tail risk drives the aggregate demand for consumption goods through a time-varying precautionary saving motive, generating cyclicality in firm cash flows. In the cross section, firms facing more elastic demand are more exposed to fluctuations in idiosyncratic tail risk. This risk exposure is compensated by a significant and countercyclical risk premium in equity returns. Empirical findings support the predictions of the model.