Demographic Impacts on Life Cycle Portfolios and Financial Market Structures

31 Pages Posted: 19 Mar 2020 Last revised: 31 Mar 2020

See all articles by Weifeng Liu

Weifeng Liu

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

Phitawat Poonpolkul

Centre for Applied Macroeconomic Analysis, ANU

Date Written: March 03, 2020

Abstract

This paper provides a framework to endogenize rates of return for risk-free bonds and risky capital in an overlapping generation model. The rate of return on capital is endogenized by introducing idiosyncratic production shocks to avoid computation challenges associated with aggregate production shocks in the literature. The framework enables the interaction between financial markets and macroeconomic conditions in a production economy. Based on this framework, the paper first examines life-cycle portfolio choice without demographic change, and illustrates that several factors such as borrowing costs, labor income and production risk play important roles in life-cycle portfolios. The paper then investigates the impacts of population aging on macroeconomic conditions, life-cycle behaviors and financial market structures. The results show that population aging leads to higher capital-labor ratios, and reduces the rates of return on both assets. The bond market shrinks significantly, and capital decreases if the fertility rate declines but increases if the mortality rate declines, leading to structural change in financial markets. The impacts on life-cycle variables are quite different in the fertility and mortality cases particularly at the late stage of life.

Keywords: Demographic change, portfolio choice, financial market structure, risk premium, idiosyncratic production shock, overlapping generation model.

JEL Classification: J11, G11, C63, C68, E21, E23

Suggested Citation

Liu, Weifeng and Poonpolkul, Phitawat, Demographic Impacts on Life Cycle Portfolios and Financial Market Structures (March 03, 2020). CAMA Working Paper No. 20/2020, Available at SSRN: https://ssrn.com/abstract=3557012 or http://dx.doi.org/10.2139/ssrn.3557012

Weifeng Liu (Contact Author)

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

Crawford School of Public Policy
Canberra, Australian Capital Territory 2601
Australia

HOME PAGE: http://https://cama.crawford.anu.edu.au/

Phitawat Poonpolkul

Centre for Applied Macroeconomic Analysis, ANU ( email )

Australia

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