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Mass Customization in Life-Cycle Investing Strategies with Income Risk

Romain Deguest, Lionel Martellini and Vincent Milhau
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Romain Deguest: EDHEC-Risk Institute
Lionel Martellini: EDHEC Business School, EDHEC Risk Institute, ERI Scientific Beta
Vincent Milhau: EDHEC-Risk Institute

Bankers, Markets & Investors, 2015, issue 139, 28-44

Abstract: Formal intertemporal portfolio selection models show that the utility maximizing strategy for an individual investor depends on a number of subjective characteristics such as the investor’s horizon, risk aversion and non-financial income, in addition to depending on market conditions. These insights are vastly ignored by current forms of target date fund products, which most often propose a deterministic decrease in the equity allocation regardless of market conditions, and ignore the question of labor income risk. This paper shows that, in spite of a high degree of heterogeneity in individual investors’ income streams, grouping investors with similar income profiles, and implementing a unique investment strategy for all members of a given class, involves only a limited welfare cost with respect to an idealized fully customized strategy. Our results also suggest that these strategies consistent with mass-customization constraints strongly dominate allocation strategies that completely ignore the presence of income risk.

Keywords: Human Capital; Income Risk; Optimal Portfolio (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Date: 2015
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