Portfolio Choice, Liquidity Constraints and Stock Market Mean Reversion

Alexander Michaelides

No 2823, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This Paper solves numerically for the optimal consumption and portfolio choice of an infinitely lived investor facing short sales and borrowing constraints, undiversifiable labour income risk and a predictable time varying equity premium. The investor aggressively times the market while positive correlation between permanent earnings shocks and stock return innovations generates a substantial hedging demand for the riskless asset. Moreover, a speculative increase in savings arises when stock returns are expected to be high and conversely when future returns are expected to be low. Small information/optimization costs can make it optimal for an investor to assume i.i.d excess stock returns, both because liquidity constraints can be frequently binding and because households can smooth idiosyncratic earnings shock using a small buffer stock of wealth.

Keywords: Buffer stock saving; Liquidity constraints; Portfolio choice; Stock market mean reversion; Stock market predictability (search for similar items in EconPapers)
JEL-codes: E21 G11 (search for similar items in EconPapers)
Date: 2001-06
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://cepr.org/publications/DP2823 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Working Paper: Portfolio Choice, Liquidity Constraints and Stock Market Mean Reversion (2001)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:2823

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP2823

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().