Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence

50 Pages Posted: 26 May 2003

See all articles by Francisco Gomes

Francisco Gomes

London Business School

Alexander Michaelides

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: April 2003

Abstract

We show that a life-cycle model with realistically calibrated uninsurable labor income risk and moderate risk aversion can simultaneously match stock market participation rates and asset allocation decisions conditional on participation. The key ingredients of the model are Epstein-Zin preferences, two risky assets (stocks and long-term bonds), and a fixed entry cost associated with the investment in risky assets. In this context, moderate preference heterogeneity in risk aversion and in the elasticity of intertemporal substitution is sufficient to deliver our results. Moreover, the model rationalizes the asset allocation puzzle of Canner, Mankiw and Weil (1997).

Keywords: Life-Cycle Models, Portfolio Choice, Preference Heterogeneity, Liquidity Constraints, Stock Market Participation, Uninsurable Labor Income Risk

JEL Classification: G11

Suggested Citation

Gomes, Francisco and Michaelides, Alexander, Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence (April 2003). Available at SSRN: https://ssrn.com/abstract=401441 or http://dx.doi.org/10.2139/ssrn.401441

Francisco Gomes (Contact Author)

London Business School ( email )

Institute of Finance and Accounting
Sussex Place - Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 7724 3317 (Fax)

HOME PAGE: http://www.london.edu/faculty/fgomes

Alexander Michaelides

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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