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Precautionary saving and portfolio allocation: DP by GMM

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  • Letendre, Marc-Andre
  • Smith, Gregor W.

Abstract

There is much research on consumption-savings problems with risky labor income and a constant interest rate and also on portfolio allocation with risky returns but nonstochastic labor income. Less is known quantitatively about the interaction between the two forms of risk. Under CRRA utility, undiversifiable income risk should be reflected in both savings rates and portfolio allocations. To quantify these effects in a model of consumption and portfolio choice, we adopt a semi-parametric projection method for solving dynamic programmes, based on generalized method of moments estimation of the parameters of approximate decision rules. We find that background income risk does affect optimal portfolios but that this effect may be difficult to detect empirically.

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Bibliographic Info

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

Volume (Year): 48 (2001)
Issue (Month): 1 (August)
Pages: 197-215

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Handle: RePEc:eee:moneco:v:48:y:2001:i:1:p:197-215

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Web page: http://www.elsevier.com/locate/inca/505566

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Citations

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Cited by:
  1. Luis M. Viceira, 1999. "Optimal Portfolio Choice for Long-Horizon Investors with Nontradable Labor Income," NBER Working Papers 7409, National Bureau of Economic Research, Inc.
  2. Luc Arrondel & Hector Calvo Pardo & Xisco Oliver, 2007. "Temperant portfolio choice and background risk: evidence from France," PSE Working Papers halshs-00588069, HAL.
  3. Letendre, Marc-Andre, 2004. "Semi-parametric predictions of the intertemporal approach to the current account," Journal of International Economics, Elsevier, vol. 64(2), pages 363-386, December.
  4. Wilson, Bonnie, 2003. "Diversification of risk and saving," The Quarterly Review of Economics and Finance, Elsevier, vol. 43(4), pages 697-712.
  5. repec:hal:wpaper:halshs-00588069 is not listed on IDEAS
  6. Feigenbaum, James, 2005. "Second-, third-, and higher-order consumption functions: a precautionary tale," Journal of Economic Dynamics and Control, Elsevier, vol. 29(8), pages 1385-1425, August.
  7. Veld-Merkoulova, Yulia V., 2011. "Investment horizon and portfolio choice of private investors," International Review of Financial Analysis, Elsevier, vol. 20(2), pages 68-75, April.
  8. Sule Alan, 2004. "Precautionary Wealth and Portfolio Allocation: Evidence from Canadian Microdata," Social and Economic Dimensions of an Aging Population Research Papers 117, McMaster University.
  9. Jaime Ruiz-Tagle, 2006. "Financial Markets Incompleteness and Inequality Over the Life-Cycle," Working Papers Central Bank of Chile 405, Central Bank of Chile.

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