The Power of Human Capital in Lifecycles. Insights from a Flexible Framework

33 Pages Posted: 22 Feb 2025

See all articles by William Lim

William Lim

Australian National University (ANU)

Gaurav Khemka

Australian National University (ANU)

Marcos Escobar-Anel

Western University

Date Written: November 25, 2024

Abstract

This paper develops a novel and flexible life-cycle framework, where borrowing human capital plays an explicit role in modeling and decision-making, explicitly impacting risk-aversion levels, borrowing rates, and inter-temporal discount rates. We solve this new ``double'' optimization problem in semi-closed form in a region of the control/policy space while developing a numerical procedure to approximate the remaining region using the solvable cases. We carry out numerical case studies revealing two unprecedented conclusions. First, the optimal level of human capital borrowings depends non-trivially on many characteristics of the investor and the market, e.g., range of borrowing cost and risk aversion, subjective discount rate, future income level, and size of their initial endowment. Second, we observe a high level of welfare losses when investors fail to take advantage of their human capital; for instance, investors with high endowment could experience a welfare loss exceeding 70%, while investors with high income could see a 20% welfare loss.

Keywords: Utility maximization, Human capital modelling, Investor's life cycle, Borrowing costs, Welfare loss

Suggested Citation

Lim, William and Khemka, Gaurav and Escobar-Anel, Marcos, The Power of Human Capital in Lifecycles. Insights from a Flexible Framework (November 25, 2024). Available at SSRN: https://ssrn.com/abstract=5108159 or http://dx.doi.org/10.2139/ssrn.5108159

William Lim (Contact Author)

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Gaurav Khemka

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Marcos Escobar-Anel

Western University ( email )

1151 Richmond St
London, Ontario N6A 3K7
Canada

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
25
Abstract Views
123
PlumX Metrics