Portfolio choice over the life-cycle in the presence of 'trickle down' labor income
By: Luca Benzoni, Pierre Collin-Dufresne, Robert S. Goldstein.
Contributors: Dufresne, Pierre Collin.; Goldstein, Robert S.; National Bureau of Economic Research.
Series: NBER working paper series ;; working paper 11247; Working paper series (National Bureau of Economic Research : Online) ;; working paper no. 11247.
Publisher: National Bureau of Economic Research
Published: 2005
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Subjects: Portfolio management -- Mathematical models.; Investments -- Mathematical models.; Income -- Mathematical models.
Description: "Empirical evidence shows that changes in aggregate labor income and stock market returns exhibit only weak correlation at short horizons.  As we document below, however, this correlation increases substantially at longer horizons, which provides at least suggestive evidence that stock returns and labor income are cointegrated.  In this paper, we investigate the implications of such a cointegrated relation for life-cycle optimal portfolio and consumption decisions of an agent whose non-tradable labor income faces permanent and temporary idiosyncratic shocks.  We find that, under economically plausible calibrations, the optimal portfolio choice for the young investor is to take a substantial {\em short} position in the risky portfolio, in spite of the large risk premium associated with it.  Intuitively, this occurs because the cointegration effect makes the present value of future labor income flows 'stock-like' for the young agent.  However, for older agents who have shorter times-to-retirement, the cointegration effect does not have sufficient time to act, and the remaining human capital becomes more 'bond-like.' Together, these effects create a hump-shaped optimal portfolio decision for the agent over the life cycle, consistent with empirical observation"--National Bureau of Economic Research web site.
Notes: Includes bibliographical references.
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