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When Can Life-Cycle Investors Benefit from Time-Varying Bond Risk Premia?

49 Pages Posted: 1 Mar 2007 Last revised: 4 Feb 2009

Ralph S. J. Koijen

New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Theo Nijman

Tilburg University - Center and Faculty of Economics and Business Administration

Bas J. M. Werker

Tilburg University - Center for Economic Research (CentER)

Multiple version iconThere are 2 versions of this paper

Date Written: February 3, 2009

Abstract

We study the economic importance of time-varying bond risk premia in a life-cycle consumption and portfolio-choice problem for an investor facing short-sales and borrowing constraints. On average, the investor is able to time bond markets only as of age~45. Tilts in the optimal asset allocation in response to changes in bond risk premia exhibit pronounced life-cycle patterns. Taking as a point of reference an investor who conditions only on age and wealth, we compute the management fee this investor is willing to pay to account for either current risk premia or for both current and future risk premia. We find the fees to account for current risk premia to be economically sizeable, ranging up to 1\% per annum, but this fee is comparable to the fee of the fully optimal strategy. To solve our model, we extend recently developed simulation-based techniques to life-cycle problems featuring multiple state variables and multiple risky assets.

Keywords: bond risk premia, life-cycle consumption, portfolio choice

JEL Classification: D91, E43, G11, G12

Suggested Citation

Koijen, Ralph S. J. and Nijman, Theo and Werker, Bas J. M., When Can Life-Cycle Investors Benefit from Time-Varying Bond Risk Premia? (February 3, 2009). EFA 2007 Ljubljana Meetings Paper. Available at SSRN: https://ssrn.com/abstract=795925 or http://dx.doi.org/10.2139/ssrn.795925

Ralph S. J. Koijen (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://www.koijen.net

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Theo E. Nijman

Tilburg University - Center and Faculty of Economics and Business Administration ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2342 (Phone)
+31 13 466 3280 (Fax)

Bas J.M. Werker

Tilburg University - Center for Economic Research (CentER) ( email )

Econometrics and Finance Group
5000 LE Tilburg
Netherlands

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