Life-Cycle Portfolio Choice: The Role of Heterogeneity and Under-diversification

Claudio Campanale ()

Working Papers. Serie AD from Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie)

Abstract: The empirical work on household portfolio choice documents two facts. One, the stock market participation rate is low and hump-shaped over the life-cycle, two, the conditional share of stocks is also low but does not appear to change much during the life-cycle. In contrast the standard life-cycle portfolio choice model predicts high and monotonically increasing participation rates and conditional stock shares that are low and exhibit dramatic changes with age. In this paper I consider a number of extensions to this basic framework. I find that a small per period participation cost is needed to generate a hump shaped life-cycle profile of participation rates. Under a realistic calibration the quantitative effect is minor. Progressive social security and the assumption that the risk of stock portfolios is declining in household wealth as a consequence of better diversification opportunities 'an assumption that has some empirical support' though provide substantial amplification and significantly improve the ability of the model to match the data. Under-diversification also reduces the average portfolio share of stocks conditional on participation and, together with the intergenerational transmission of wealth makes it insensitive to age, consistent with the empirical evidence.

Keywords: Portfolio choice; life-cycle; bequests; diversification; social security. (search for similar items in EconPapers)
Pages: 44 pages
Date: 2008-03
New Economics Papers: this item is included in nep-dge and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:ivi:wpasad:2008-06

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