Portfolio Choice with Sustainable Spending: A Model of Reaching for Yield
54 Pages Posted: 20 Apr 2020 Last revised: 5 Nov 2022
Date Written: April 2020
We show that reaching for yield -- a tendency to take more risk when the real interest rate declines while the risk premium remains constant -- results from imposing a sustainable spending constraint on an otherwise standard infinitely lived investor with power utility. When the interest rate is initially low, reaching for yield intensifies. The sustainable spending constraint also affects the response of risktaking to a change in the risk premium, which can even change sign. In a variant of the model where the sustainable spending constraint is formulated in nominal terms, low inflation also encourages risktaking.
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