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 based on different models of the world. We use detailed controls to rule out the main nonbelief-based channels such as 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.

Recessions are typically associated with lower firm cashflows and higher discount rates. We show that these two components have very different implications for labor income growth. Higher discount rates lead to lower worker earnings for workers at the bottom of the income distribution; these declines are primarily driven by job separations. By contrast, lower cashflow (or productivity) news is followed by declines in earnings for workers at the top of the income distribution, with most of the effect coming from the intensive margin. We build an equilibrium model of labor market search that quantitatively replicates these facts. The model matches several stylized features of the data: the level of unemployment volatility with procyclical job finding rates and countercyclical job destruction rates; countercyclical tail risk in labor income growth; the low level of cyclicality of the average wage; the U-shaped sensitivity of worker earnings to aggregate output by prior income; and the cyclical evolution of income inequality.

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.