Countercyclical Risks and Portfolio Choice Over the Life Cycle: Evidence and Theory
73 Pages Posted: 15 Mar 2019
Date Written: September 13, 2018
I show that countercyclical earnings dynamics can have quantitatively important effects on saving and portfolio choice decisions over the life cycle. During expansions (recessions) when expected future earnings growth is high (low), households save less (more) and also invest a higher (lower) share of their financial wealth in the stock market. Negative skewness in the earnings process during recessions further reduces households' stock market exposure and consumption. These quantitative predictions are consistent with microeconometric evidence from the Panel Study of Income Dynamics and macroeconometric evidence from the Flow of Funds. Counterfactual simulations using the calibrated model generate wealth inequality dynamics similar to their empirical counterparts.
Keywords: Countercyclical Labor Income Risk, Business Cycles, Life-cycle Portfolio Choice, Wealth Inequality.
JEL Classification: D31, D63, D91, E21, E32, G11.
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