Optimal Life-Cycle Portfolios for Heterogeneous Workers
Forthcoming, Review of Finance © by Oxford University Press
Posted: 11 Aug 2013 Last revised: 3 Jul 2017
Date Written: June 25, 2013
Household portfolios include risky bonds, beyond stocks, and respond to permanent labour income shocks. This paper brings these features into a life-cycle setting, and shows that optimal stock investment is constant or increasing in age before retirement for realistic parameter combinations. The driver of such inversion in the life-cycle profile is the resolution of uncertainty regarding social security pension, which increases the investor's risk appetite. This occurs if a small positive contemporaneous correlation between permanent labour income shocks and stock returns is matched by a realistically high variance of such shocks and/or risk aversion. Absent this combination, the typical downward sloping profile obtains. Overlooking differences in optimal investment profiles across heterogeneous workers results in large welfare losses, in the order of 15-30% of lifetime consumption.
Keywords: Household portfolios include risky bonds, beyond stocks, respond to permanent labour income shocks
JEL Classification: J11, D91
Suggested Citation: Suggested Citation