Labor Supply Flexibility and Portfolio Choice in a Life-Cycle Model

41 Pages Posted: 8 Jun 2004  

Zvi Bodie

Boston University - Department of Finance & Economics

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Harvard Business School - Finance Unit

William F. Samuelson

Boston University - Department of Finance & Economics; National Bureau of Economic Research (NBER)

Date Written: January 1992

Abstract

This paper examines the effect of the labor-leisure choice on portfolio and consumption decisions over an individual's life cycle. The model incorporates the fact that individuals may have considerable flexibility in varying their work effort (including their choice of when to retire). Given this flexibility, the individual simultaneously determines optimal levels of current consumption, labor effort, and an optimal financial investment strategy at each point in his life cycle. We show that labor and investment choices are intimately related. The ability to vary labor supply ex post induces the individual to assume greater risks in his investment portfolio ex ante. The model explains why the young (enjoying greater labor flexibility over their working lives) may take greater investment risks than the old. It also offers an explanation as to why consumption spending is relatively "smooth" despite volatility in asset prices. Finally, the paper provides a compact method for valuing the risky cash flows associated with future wage income.

Suggested Citation

Bodie, Zvi and Merton, Robert C. and Samuelson, William F., Labor Supply Flexibility and Portfolio Choice in a Life-Cycle Model (January 1992). NBER Working Paper No. w3954. Available at SSRN: https://ssrn.com/abstract=420291

Zvi Bodie (Contact Author)

Boston University - Department of Finance & Economics ( email )

United States

HOME PAGE: http://www.zvibodie.com

Robert C. Merton

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Avenue
E62-634
Cambridge, MA 02139-4307
United States
617 715 4866 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6678 (Phone)

William F. Samuelson

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Paper statistics

Downloads
169
Rank
144,552
Abstract Views
2,208