Hedging Labor Income Risk over the Life-Cycle

Fabio Bagliano, Raffaele Corvino, Carolina Fugazza and Giovanna Nicodano

No 576, Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: We show that the decision to participate in the stock market depends on the ability of equities to hedge the individual permanent earnings shocks, consistent with implications of life-cycle models. Those households who refrain from stock investing display positive correlation between their own permanent income innovations and market returns. These results owe to a two-step empirical strategy. First, a minimum distance estimation disentangles the aggregate from the idiosyncratic permanent component of labor income risks. The second step reconstructs the individual life-cycle dynamics of persistent shocks through a Kalman filter applied to the estimated labor income process. We are thus able to obtain the full cross-sectional distribution of individual correlations between permanent shocks and market returns.

Keywords: Stock market participation; Labor income-risk return correlation; Permanent income shocks; Kalman filter. (search for similar items in EconPapers)
JEL-codes: C15 D14 G10 G11 (search for similar items in EconPapers)
Pages: pages 40
Date: 2018
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Working Paper: Hedging Labor Income Risk over the Life-Cycle (2018)
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