Life-Cycle Portfolio Choice, the Wealth Distribution and Asset Prices

Abstract

This paper examines a canonical stochastic overlapping generations model with dynamically complete markets. Belief differences lead agents to place bets against each other and so wealth shifts across agents and across generations. Such changes in the wealth distribution strongly affect prices of long-lived assets since older generations have a lower propensity to save than younger generations. Contrary to the prices of long-lived assets, prices of short-lived assets are much less affected by the wealth distribution. Therefore, belief heterogeneity and life-cycle concerns are major forces contributing to the large gap between the volatility of stock returns and of the risk-free rate found in U.S. data.

Keywords: OLG economy, heterogeneous beliefs, wealth distribution, asset price volatility

JEL Classification: D53, E21, G11, G12