Abstract

http://ssrn.com/abstract=242138
 
 

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Occupation-Level Income Shocks and Asset Returns: Their Covariance and Implications for Portfolio Choice


Steven J. Davis


University of Chicago; National Bureau of Economic Research (NBER)

Paul Willen


Federal Reserve Bank of Boston - Research Department; National Bureau of Economic Research (NBER)

September 2000

NBER Working Paper No. w7905

Abstract:     
This paper develops and applies a simple graphical approach to portfolio selection that accounts for covariance between asset returns and an investor's labor income. Our graphical approach easily handles income shocks that are partly hedgable, multiple risky assets, many periods and life cycle considerations. We apply the approach to occupation-level components of individual income innovations estimated from repeated cross sections of the Current Population Survey. We characterize several properties of these innovations, including their covariance with aggregate equity returns, long-term bond returns and returns on several other assets. Aggregate equity returns are uncorrelated with the occupation-level income innovations, but a portfolio formed on firm size is significantly correlated with income innovations for several occupations, and so are selected industry-level equity portfolios. An application of the theory to the empirical results shows (a) large predicted levels of risky asset holdings compared to observed levels, (b) considerable variation in optimal portfolio allocations over the life cycle, and (c) large departures from the two-fund separation principle.

Number of Pages in PDF File: 70

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Date posted: September 16, 2000  

Suggested Citation

Davis, Steven J. and Willen, Paul, Occupation-Level Income Shocks and Asset Returns: Their Covariance and Implications for Portfolio Choice (September 2000). NBER Working Paper No. w7905. Available at SSRN: http://ssrn.com/abstract=242138

Contact Information

Steven J. Davis (Contact Author)
University of Chicago ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7312 (Phone)
773-702-0458 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Paul Willen
Federal Reserve Bank of Boston - Research Department ( email )
600 Atlantic Avenue
Boston, MA 02210
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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