Using a calibrated, collective life-cycle portfolio choice model for a dual-income couple, we show that an increase in the ability to share risk within the household due to a mean-preserving spread in the partners’ coefficients of relative risk aversion leads to a substantial increase in financial risk-taking. Importantly, we show that risk sharing has a larger economic impact on portfolio choice than risk diversification. While unitary models usually do not fully replicate the optimal portfolio choice of collective models, we propose approximations that work reasonably well for moderate background risk. We provide strong empirical support for our key findings.

We show that incorporating defined benefit pension funds in an incomplete markets asset pricing model improves its ability to match the historical equity premium and riskless rate and has important risk‐sharing implications. We document the importance of the pension fund's size and asset demands, and a new risk channel arising from fluctuations in the fund's returns. We use our calibrated model to study the implications of a shift to an economy with defined contribution plans. The new steady state is characterized by a higher riskless rate and a lower equity premium. Consumption volatility increases for retirees but decreases for workers.