Wealthy HtM during the Global Financial Crisis, Portfolio Rebalancing with State-Dependent Adjustment Costs

I examine the portfolio choices of wealthy hand-to-mouth households during severe crises and their implications for fiscal policy. In standard two-asset models, exemplified by Kaplan and Violante (2014) and extended by Aguiar, Bils, and Boar (2025), large aggregate shocks lead wealthy hand-to-mouth households to liquidate illiquid assets, increase liquid wealth, and thereby reduce their marginal propensity to consume (MPC) out of government transfers. This mechanism implies that transfers become less effective precisely in deep recessions, suggesting that governments should refrain from using them in such episodes. I instead study crises in which an aggregate income shock is accompanied by a temporary decline in the price of illiquid assets, à la Gertler and Kiyotaki (2015), making asset sales less profitable. This setup is designed to capture key features of the 2008 Global Financial Crisis. Introducing state-dependent liquidation costs reduces the likelihood that wealthy hand-to-mouth households transition into non-hand-to-mouth status following a shock, bringing the model in line with PSID evidence on hand-to-mouth dynamics used by Aguiar, Bils, and Boar (2025).