Countercyclical Labor Income Risk and Portfolio Choices over the Life Cycle
66 Pages Posted: 13 May 2016 Last revised: 24 Aug 2021
Date Written: July 21, 2020
Abstract
I estimate a life-cycle model of portfolio choices that incorporates the relationship between market returns and the skewness of idiosyncratic income shocks. The cyclicality of skewness can explain (i) low stock market participation among young households, (ii) why the equity share of participants slightly increases until retirement and (iii) why renters invest less in stocks than homeowners. With a relative risk aversion of 6 and yearly participation cost of $250, the model matches the evolution of wealth, participation and conditional equity shares over the life cycle. Nonetheless, cyclical skewness increases the equity premium by at most 0.5 percentage points.
Keywords: Household finance, Labor income risk, Portfolio choices, Human capital, Life-cycle model, Simulated method of moments
JEL Classification: G11, G12, D14, D91, J24, H06
Suggested Citation: Suggested Citation