Collateralized Borrowing And Life-Cycle Portfolio Choice
Federal Reserve Bank of Boston - Research Department; National Bureau of Economic Research (NBER)
University of Zurich; Swiss Finance Institute
FRB of Boston Working Paper No. 06-4
AFA 2007 Chicago Meetings Paper
We examine the effects of collateralized borrowing in a realistically parameterized life-cycle portfolio choice problem. We provide basic intuition in a two-period model and then solve a multi-period model computationally. Our analysis provides insights into life-cycle portfolio choice relevant for researchers in macroeconomics and finance. In particular, we show that standard models with unlimited borrowing at the riskless rate dramatically overstate the gains to holding equity when compared with collateral-constrained models. Our results do not depend on the specification of the collateralized borrowing regime: the gains to trading equity remain relatively small even with the unrealistic assumption of unlimited leverage. We argue that our results strengthen the role of borrowing constraints in explaining the portfolio participation puzzle, that is, why most investors do not own stock.
Number of Pages in PDF File: 48
Keywords: portfolio choice, collateral
JEL Classification: G11,E21working papers series
Date posted: March 17, 2006
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