For the past 160 years, the racial wealth gap has been a persistent feature of US society. While some progress has been made in closing the wealth gap, modern history paints a different picture of the racial wealth gap: since the 1980s, the racial wealth gap has not only remained unchanged but has begun to widen again. In Derenoncourt et al. (2024a), we explore how these divergent trends can be linked to differences in portfolio structures between Black and white Americans.
White Americans invest a larger share of their wealth in the stock market. Data from the Survey of Consumer Finances reveal that the gap in stock market participation between white and Black Americans is approximately 20 percentage points, with the equity share of Black financial wealth portfolios being 10 percentage points lower than those of white portfolios. Hence, Black households benefitted over the past 40 years substantially less from the booming stock market. Understanding the reasons for these portfolio differences is therefore a crucial step to understand the dynamics of the racial wealth gap today.
Various studies highlight the roles of income levels and educational attainment in explaining differences in portfolio choices, suggesting that disparities in income and education between Black and white Americans contribute to the lower investment in high-return assets by Black Americans (Dynan et al. 2004, Cole and Shastry 2009, Van Rooij et al. 2011, Bucher-Koenen and Ziegelmeyer 2014, Blau and Graham 1990). Additionally, Boerma and Karabarbounis (2023) examine how pessimistic beliefs about future returns from risky assets influence the investment decisions of Black Americans.
In new research (Derenoncourt et al. 2024b), we add to this discourse by demonstrating the impact of differences in unemployment risk between Black and white Americans on their investment choices in risky assets. Unlike previous studies, our research highlights how the racial gap in risky-asset investment can be explained by rational behaviour in the presence of differences in unemployment risk.
Large racial differences in cyclical unemployment risk
A substantial body of research underscores the relationship between labour market dynamics and portfolio choices: households exposed to more labour market risk tend to prioritise savings in safer, more liquid assets as a buffer against the economic fallout of labour market downturns (Guiso et al. 1996, Palia et al. 2014, Basten et al. 2016, Chang et al. 2018). Specifically, economic downturns typically result in increased unemployment risk and longer unemployment duration, which explains the empirically observed increase in the left tail of the income growth distribution (Kocherlakota and Pistaferri 2009, Guvenen et al. 2014, Hall 2017, Hubmer 2018, Catherine 2021, Busch et al. 2022, Guvenen et al. 2022).
Using data from the Current Population Survey and the Panel Study of Income Dynamics, we document for the post-1980 period that Black Americans have faced significantly higher cyclical unemployment risks than their white counterparts. Table 1 presents the labour market flows for Black and white workers during recessions and booms, indicating that Black workers consistently face worse labour market conditions across all states of the economy. Conditions are particularly bad during recessions, with a notable decrease in the likelihood of Black Americans finding employment after being unemployed – particularly for those who are long-term unemployed. For Black individuals unemployed for more than one year, the unemployment exit rate drops by 11.4% from booms to recessions, a figure nearly double the reduction experienced by white workers, whose unemployment exit rate decreases by only 5.9% when the economy enters a recession.
Table 1 Black and white labour market flows: Recessions versus booms
This heightened exposure to cyclical unemployment risks results in disproportionately larger earnings losses for Black Americans during recessions compared to white Americans. Figure 1 visualises the lower tail of the distribution of labour income growth for Black and white workers, defined as the difference between the 50th percentile and 10th percentile of observed growth rates (L5010). This visualisation supports the findings of increased unemployment risk during recessions, with an observable expansion in the left tail for both Black and white households at the onset of recessions, which then contracts as the economy begins to recover. This expansion is significantly more pronounced for Black households.
Figure 1 The bottom tail of the Black and white income distribution
Notes: Figure 1 visualises the lower tail of the distribution of labour income growth for Black and white workers, defined as the difference between the 50th percentile and 10th percentile of observed growth rates (L5010).
By regressing the Black and white L5010 measures with S&P 500 stock market returns, we further show that the unemployment risk for Black Americans is more negatively correlated with stock market dynamics than that of white workers. This stronger correlation supports the idea that Black Americans may rationally invest more cautiously in equity, as their assets tend to lose value precisely when they need them to cover income losses from unemployment.
Unemployment risk and the racial equity gap
Based on this empirical evidence, we rely on a stylised life-cycle model with portfolio choice to quantify the contribution of cyclical unemployment risk to the racial portfolio gap in stock market investments. The model is calibrated to match key dynamics in unemployment risk differentials across Black and white Americans. First, we differentiate the labour market transition probabilities between boom and recession periods, noting that Black Americans face a higher risk of becoming unemployed and remaining unemployed for longer. Second, aligning with findings from Skandalis et al. (2022), Black Americans effectively receive less unemployment insurance benefits.
Table 2 illustrates the simulated differences in equity shares between white and Black Americans’ financial wealth portfolios. Our results confirm the importance of cyclical unemployment risk in explaining the racial gap in equity investment. In our baseline model, the higher unemployment risk faced by Black Americans explains around 90% of the differences in equity shares in financial wealth portfolios. Looking at the different dimensions of racial labour market gaps, we find the cyclicality of job-finding rates to play the most important role on portfolio choices. If Black and white Americans faced the same job-finding rates and the only difference would be in the probability of becoming unemployed and the unemployment-insurance benefits, then the equity-share gap would fall to 3.1 percentage points, which is 40% of the observed gap.
Table 2 Data versus the model: White-to-Black equity gaps
Notes: Table 2 illustrates the simulated differences in equity shares between white and Black Americans’ financial wealth portfolios. Our benchmark specification, shown in column 2, incorporates racial differences in two key areas: (i) race-dependent cyclical labour market transition rates, and (ii) disparities in unemployment insurance benefits. Column 3 presents simulation results under the assumption that unemployment-benefit replacement rates are equal across both races. Furthermore, column 4 explores the impact of differences in the job-finding rate on the equity investment gap by closing the gap in job-finding rates and considering only racial differences in job-loss rates. We compare our model predictions to the data in the first column: according to the Survey of Consumer Finances for the years 1983–2019, the average racial gap in equity share is around 8 percentage points.
Conclusion
Our study highlights the vital role of heightened cyclical unemployment risk faced by Black Americans in explaining widening racial wealth disparities since 1980. While current policy discussions focus on improving financial inclusion for minorities, our findings introduce a crucial insight: without better labour market conditions for Black Americans, their participation in the equity market will remain lower, which in turn negatively affects their wealth accumulation dynamics. During periods of rising equity prices, this cautious approach to equity investment tends to exacerbate the racial wealth gap. Our research underscores the necessity of addressing labour market inequalities to foster more equitable financial participation and wealth accumulation among Black Americans.
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