Optimal Life-Cycle Portfolios for Heterogeneous Workers
46 Pages Posted: 19 Aug 2013
Date Written: June 28, 2013
Household portfolios include risky bonds, beyond stocks, and respond to permanent labour income shocks. This paper brings these features into a life-cycle setting, and shows that optimal stock investment is constant or increasing in age before retirement for realistic parameter combinations. The driver of such inversion in the life-cycle profile is the resolution of uncertainty regarding social security pension, which increases the investor’s risk appetite. This occurs if a small positive contemporaneous correlation between permanent labour income shocks and stock returns is matched by a realistically high variance of such shocks and/or risk aversion. Absent this combination, the typical downward sloping profile obtains. Overlooking differences in optimal investment profiles across heterogeneous workers results in large welfare losses, in the order of 15-30% of lifetime consumption.
Keywords: Life-cycle portfolio choice, background risk, age rule, investor heterogeneity, stock market participation
Suggested Citation: Suggested Citation