Portfolio Choice over the Life-Cycle in the Presence of 'Trickle Down' Labor Income

Luca Benzoni, Pierre Collin-Dufresne and Robert S. Goldstein

No 11247, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Empirical evidence shows that changes in aggregate labor income and stock market returns exhibit only weak correlation at short horizons. As we document below, however, this correlation increases substantially at longer horizons, which provides at least suggestive evidence that stock returns and labor income are cointegrated. In this paper, we investigate the implications of such a cointegrated relation for life-cycle optimal portfolio and consumption decisions of an agent whose non-tradable labor income faces permanent and temporary idiosyncratic shocks. We find that, under economically plausible calibrations, the optimal portfolio choice for the young investor is to take a substantial {\em short} position in the risky portfolio, in spite of the large risk premium associated with it. Intuitively, this occurs because the cointegration effect makes the present value of future labor income flows `stock-like' for the young agent. However, for older agents who have shorter times-to-retirement, the cointegration effect does not have sufficient time to act, and the remaining human capital becomes more `bond-like.' Together, these effects create a hump-shaped optimal portfolio decision for the agent over the life cycle, consistent with empirical observation.

JEL-codes: E2 E3 G1 (search for similar items in EconPapers)
Date: 2005-04
New Economics Papers: this item is included in nep-fin, nep-mac and nep-sea
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (27)

Published as Benzoni, Luca, Pierre Collin-Dufresne and Robert S. Goldstein. "Portfolio Choice over the Life-Cycle when the Stock and Labor Markets Are Cointegrated." The Journal of Finance 62,5 (2007): 2123-2167.

Downloads: (external link)
http://www.nber.org/papers/w11247.pdf (application/pdf)

Related works:
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:nbr:nberwo:11247

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w11247

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().