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Dynamic asset allocation with stochastic income and interest rates

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Author Info

  • Munk, Claus
  • Sørensen, Carsten

Abstract

We solve for optimal portfolios when interest rates and labor income are stochastic with the expected income growth being affine in the short-term interest rate in order to encompass business cycle variations in wages. Our calibration based on the Panel Study of Income Dynamics (PSID) data supports this relation with substantial variation across individuals in the slope of this affine function. The slope is crucial for the valuation and riskiness of human capital and for the optimal stock/bond/cash allocation both in an unconstrained complete market and in an incomplete market with liquidity and short-sales constraints.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 96 (2010)
Issue (Month): 3 (June)
Pages: 433-462

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Handle: RePEc:eee:jfinec:v:96:y:2010:i:3:p:433-462

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Web page: http://www.elsevier.com/locate/inca/505576

Related research

Keywords: Portfolio management Labor income risk Interest rate risk Business cycle Life-cycle;

References

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  1. Munk, Claus & Sorensen, Carsten, 2004. "Optimal consumption and investment strategies with stochastic interest rates," Journal of Banking & Finance, Elsevier, vol. 28(8), pages 1987-2013, August.
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Citations

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Cited by:
  1. Frank de Jong, 2005. "Valuation of pension liabilities in incomplete markets," DNB Working Papers 067, Netherlands Central Bank, Research Department.
  2. Fabio C. Bagliano & Carolina Fugazza & Giovanna Nicodano, 2012. "Optimal life-cycle portfolios for heterogeneous workers," Carlo Alberto Notebooks 266, Collegio Carlo Alberto.
  3. Koijen, R.S.J. & Nijman, T.E. & Werker, B.J.M., 2006. "Optimal Portfolio Choice with Annuitization," Discussion Paper 2006-78, Tilburg University, Center for Economic Research.
  4. Bovenberg, A.L. & Koijen, R.S.J. & Nijman, T.E. & Teulings, C.N., 2007. "Saving and investing over the life cycle and the role of collective pension funds," Open Access publications from Tilburg University urn:nbn:nl:ui:12-301942, Tilburg University.
  5. Castaneda, Pablo & Rudolph, Heinz P., 2011. "Upgrading investment regulations in second pillar pension systems : a proposal for Colombia," Policy Research Working Paper Series 5775, The World Bank.

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