48 Pages Posted: 17 Mar 2006
Date Written: March 2006
We examine the effects of collateralized borrowing in a realistically parameterized life-cycle portfolio choice problem. We provide basic intuition in a two-period model and then solve a multi-period model computationally. Our analysis provides insights into life-cycle portfolio choice relevant for researchers in macroeconomics and finance. In particular, we show that standard models with unlimited borrowing at the riskless rate dramatically overstate the gains to holding equity when compared with collateral-constrained models. Our results do not depend on the specification of the collateralized borrowing regime: the gains to trading equity remain relatively small even with the unrealistic assumption of unlimited leverage. We argue that our results strengthen the role of borrowing constraints in explaining the portfolio participation puzzle, that is, why most investors do not own stock.
Keywords: portfolio choice, collateral
JEL Classification: G11,E21
Suggested Citation: Suggested Citation
Willen, Paul and Kubler, Felix, Collateralized Borrowing And Life-Cycle Portfolio Choice (March 2006). FRB of Boston Working Paper No. 06-4; AFA 2007 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=891406 or http://dx.doi.org/10.2139/ssrn.891406