Hedging Labor Income Risk over the Life-Cycle

Fabio Bagliano, Raffaele Corvino (), Carolina Fugazza () and Giovanna Nicodano
Additional contact information
Raffaele Corvino: Faculty of Finance, Cass Business School, City, University of London, UK
Carolina Fugazza: Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy

No 58, Working papers from Department of Economics, Social Studies, Applied Mathematics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino

Abstract: We show that the decision to participate in the stock market depends on the ability of equities to hedge the individual permanent earnings shocks, consistent with implications of life-cycle models. Those households who refrain from stock investing display positive correlation between their own permanent income innovations and market returns. These results owe to a two-step empirical strategy. First, a minimum distance estimation disentangles the aggregate from the idiosyncratic permanent of labor income risks. The second step reconstructs the individual life-cycle dynamics of persistent shocks through a Kalman filter applied to the estimated labor income process. We are thus able to obtain the full cross-sectional distribution of individual correlations between permanent shock and market returns.

Keywords: Labor income-risk return correlation; Permanent income shocks; Kalman filter. (search for similar items in EconPapers)
JEL-codes: D14 G10 G11 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2018-12
New Economics Papers: this item is included in nep-fmk and nep-rmg
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http://www.bemservizi.unito.it/repec/tur/wpapnw/m58.pdf First version, 2018 (application/pdf)

Related works:
Working Paper: Hedging Labor Income Risk over the Life-Cycle (2018)
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