Using data to understand inequality

Paolo Sodini is Professor of Finance at the Stockholm School of Economics. He is the director of the Institute for Microdata (MiDa), which promotes the dissemination and use of unaggregated, individual-level financial data.

 

How do households invest during bad times, and how do they invest differently?

When times are bad and when markets fall, households tend to rebalance their investment portfolios by buying risky assets like funds and stocks, but the extent to which they do so depends on several factors, such as wealth and education levels.

“We show that people, on average, rebalance 50% of the drop in portfolio shares when markets go down,” Sodini says, adding that people who are wealthier and more financially sophisticated tend to rebalance more. 

“This group of people tends to be wealthier, more highly educated and save in private pensions. For them, the need to rebalance is lower.”

However, this is only true on average. Those at the very top tend to be less diversified, partially because they became wealthy through their own business ventures. But because they take more risks that expose them to fluctuations in the economy, the wealthiest earn higher expected returns than the rest of the population, Sodini’s research shows.

“Higher expected returns at the top tend to increase wealth inequality, but are justified by how much risk the wealthiest take, since they are more exposed to the risk of bad times... there is even more financial fragility at the top, which in turn can generate social mobility,” he says, referring to the ease of which high net-worth individuals could lose their wealth and for others to join the very rich.

Closing the gap

The researchers at MiDa have access to anonymized information on the detailed asset holdings of each person in Sweden through tax filings collected by Statistics Sweden, the country’s national statistics agency.

“We have data not only on whether they have funds, stocks, or real estate, but also information on which stock, fund, or real estate property they have over time and how much they have in them. This is the only way we can study the origins and dynamics of wealth inequality, or household financial fragility in different pockets of society,” Sodini says.

Detailed and accurate individual-level data on household finance is hard to come by as the datasets that are available in major economies like the U.S. or the Eurozone are usually collected through surveys, which can be unreliable.

“It's important that you have administrative data like in Sweden,” he says.

In 2007, however, Sweden abolished their wealth tax and the data collection that came along with it, posing a major hurdle to research and to effective policy decisions.

“They abolished the real estate register and stopped collecting information on holdings of mutual funds, stocks, and bank account balances. They also stopped collecting information about debt,” Sodini says.

“It has left the country blind. For example, we don't know where the high level of debt in Sweden really resides, and how fragile real estate markets are to the recent increases in interest rates. How much should we worry? Who is more at risk? What can the government do to avoid a major recession? Is Riksbanken increasing interest rates too much or too little? Without data, you have no hope to answer these questions.”

MiDa has made it its mission to close the gaps left by the wealth tax abolishment. For example, although the Statistics Sweden has abolished the real estate register, MiDa is using data from the Swedish Mapping, Cadastral and Land Registration Authority (Lantmäteriet) to build its own register; and when it comes to the country’s total debt, it is looking into data coming from how much Swedish households are paying in interest to find out how much debt they may have.

“We are rebuilding as many of the variables as we can, and we will be doing this through state-of-the-art statistical techniques, including machine learning,” he adds.

Sweden as a laboratory

One of the biggest questions in economics is finding out why income inequality is so much lower than wealth inequality.

“At the end of the day, wealth must be saved from income,” Sodini says. “People expect Sweden to be egalitarian, and sure, it is true for income. But for wealth, it is definitely not. This makes Sweden a very interesting laboratory to study."