Asset Allocation with Endogenous Labor Income: The Case of Incomplete Markets

59 Pages Posted: 22 Dec 2000

See all articles by Yeung Lewis Chan

Yeung Lewis Chan

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Luis M. Viceira

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Date Written: December 2000

Abstract

This paper investigates optimal consumption and portfolio decisions with nontradable labor income and flexible labor supply. This paper considers risky labor income in a setting where wage income and stock returns are not perfectly correlated. The paper provides approximate closed-form solutions to the problem, allowing for a thorough characterization of the optimal consumption and portfolio policies. These solutions show that, when labor income risk is idiosyncratic, the presence of labor/leisure choice can have dramatic positive effects on portfolio allocations relative to the benchmark in which labor income is exogenously given to the investor. The main mechanism delivering this result is that consumption becomes less sensitive to financial downfalls, thus raising the incentive to participate in the stock market.

Suggested Citation

Chan, Yeung Lewis and Viceira, Luis M., Asset Allocation with Endogenous Labor Income: The Case of Incomplete Markets (December 2000). AFA 2001 New Orleans, Available at SSRN: https://ssrn.com/abstract=254568 or http://dx.doi.org/10.2139/ssrn.254568

Yeung Lewis Chan (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong
+852 2358 7683 (Phone)
+852 2358 1749 (Fax)

Luis M. Viceira

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6331 (Phone)
617-496-6592 (Fax)

HOME PAGE: http://www.people.hbs.edu/lviceira

National Bureau of Economic Research (NBER)

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United States

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