47 Pages Posted: 8 Sep 2017 Last revised: 13 Jun 2018
Date Written: June 4, 2018
Traditional life-cycle models conclude that individuals should be fully invested in stocks when young -- in stark contrast to observed stock holdings -- and then gradually replace stocks with bonds as retirement is approaching. We show that a carefully specified and calibrated model of unemployment risk reduces the early-life stock holdings dramatically. The reduction is driven by the decline in current and expected future income caused by unemployment, the relatively high unemployment risk of young adults, and the business cycle variations in un- and reemployment probabilities that tend to deteriorate exactly when stocks perform poorly.
Keywords: Unemployment risk, Business cycle, Life-cycle model, Portfolio planning
JEL Classification: G11, D15
Suggested Citation: Suggested Citation