Is Financial Fragility a Matter of Illiquidity? An Appraisal for Italian Households

We investigate household financial fragility in Italy, providing three main contributions. First, we propose a novel characterization of financial fragility that is not necessarily linked to indebtedness, distinguishes between expected and unexpected expenses, takes portfolio composition into account, and is free of subjectivity bias. Second, we use it to assess the importance of household portfolio composition for determining the difficulties related to coping with unexpected expenditures, besides socio-economic and demographic factors. Third, we test its ability to forecast future conditions of financial distress. The empirical analysis is based on the Bank of Italy Survey on Household Income and Wealth. The results highlight the relevance of portfolio choices as determinants of financial distress, that is, they provide evidence that homeownership increases the likelihood of financial fragility while the presence of a mortgage decreases it. Moreover our measure is shown to act as an early warning indicator of distress.