Life-Cycle Portfolio Choice with Imperfect Predictors
44 Pages Posted: 18 Sep 2019 Last revised: 11 Jan 2020
Date Written: January 10, 2020
We study how imperfect predictors of stock returns affect life-cycle consumption and portfolio choice in the presence of undiversifiable labor income risk. Imperfect predictability forces investors to filter unobservable expected stock returns from realized predictive variables and stock returns and condition their decisions on the perceived conditional mean and variance of future stock returns. Recognizing the additional uncertainty from imperfect predictability, portfolios are more conservative than models with either perfect predictors or i.i.d. stock returns. The model therefore provides an explanation for why young stockholders hold conservative portfolios, and quantifies long run risks with imperfect stock market predictability.
Keywords: Portfolio Choice over the Life Cycle, Stock Market Mean Reversion, Filtering, Stock Market Predictability, Imperfect Predictor
JEL Classification: D15, G11, G5
Suggested Citation: Suggested Citation