Human Capital as an Asset Mix and Optimal Life-Cycle Portfolio: An Analytical Solution

Takao Kobayashi, Risa Sai and Kazuya Shibata
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Takao Kobayashi: Faculty of Economics, University of Tokyo
Risa Sai: Graduate School of Economics, University of Tokyo
Kazuya Shibata: Nomura Asset Management Co., Ltd.

No CARF-F-123, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: This study examines life-cycle optimal consumption and asset allocation in the presence of human capital. Labor income seems like a "money market mutual fund" whose balance in one or two years is predictable but a wide dispersion results after many years, reflecting fluctuations in economic conditions. We use the Martingale method to derive an analytical solution, finding that Mertons well- known "constant-mix strategy" is still true after incorporating human capital from the perspective of "total wealth" management. Moreover, the proportion in risky assets implicit in the agent's human capital is the main factor determining the optimal investment strategy. The numerical examples suggest that young investors should short stocks because their human capital has large market exposure. As they age, however, their human capital becomes "bond-like", and thus they have to hold stocks to achieve optimal overall risk exposure.

Pages: 34 pages
Date: 2008-06
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