Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence

Alexander Michaelides and Francisco Gomes

No 4853, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We show that a life cycle model with realistically calibrated uninsurable labour income risk and moderate risk aversion can simultaneously match stock market participation rates and asset allocation decisions conditional on participation. The key ingredients of the model are Epstein-Zin preferences, a fixed stock market entry cost, and moderate heterogeneity in risk aversion. Households with low risk aversion smooth earnings shocks with a small buffer stock of assets, and consequently most of them (optimally) never invest in equities. Therefore, the marginal stockholders are (endogenously) more risk averse, and as a result they do not invest their portfolios fully in stocks.

Keywords: Life-cycle models; Portfolio choice; Preference heterogeneity; Liquidity constraints; Stock market participation; Uninsurable labour income risk (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Date: 2005-01
New Economics Papers: this item is included in nep-fin
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Citations: View citations in EconPapers (344)

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Journal Article: Optimal Life‐Cycle Asset Allocation: Understanding the Empirical Evidence (2005)
Working Paper: Optimal life cycle asset allocation: understanding the empirical evidence (2005)
Working Paper: Optimal life-cycle asset allocation: understanding the empirical evidence (2003)
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