Optimal Consumption and Portfolio Choice For Long-Horizon Investors with Nontradable Labor Income When Asset Returns are Predictable
49 Pages Posted: 1 Oct 2011 Last revised: 22 Feb 2012
Date Written: September 7, 2011
We study the optimal consumption and investment choice for long-horizon investors with nontradable labor income and time-varying investment opportunities. Our results suggest that the popular investment recommendation that more conservative investors should hold a higher bond/stock ratio may lack theoretical justification when labor income is considered. The allocation to stock inherits the inverted U-shaped pattern of labor income growth with respect to expected time until retirement. Performance test shows the welfare loss of ignoring asset return predictability in the presence of nontradable labor income can be economically significant.
Keywords: portfolio choice, consumption, predictability, labor income
JEL Classification: G11, G12
Suggested Citation: Suggested Citation