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Consumption smoothing and portfolio rebalancing: The effects of adjustment costs

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  • Bonaparte, Yosef
  • Cooper, Russell
  • Zhu, Guozhong

Abstract

A household's response to income and return shocks depends on the costs of portfolio adjustment. In particular, the extent of portfolio rebalancing and consumption smoothing are influenced by the presence of non-convex portfolio adjustment costs. Suppose bonds can be adjusted costlessly while adjustments to stock accounts entail adjustment costs. Due to these portfolio adjustment costs, the household demands both stocks and bonds. A household can buffer some income fluctuations without incurring adjustment costs and engage in costly portfolio rebalancing less frequently. Using the estimated preference parameters and portfolio adjustment costs, the response to income and return shocks is nonlinear and reflects the interaction of portfolio rebalancing and consumption smoothing.

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Bibliographic Info

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

Volume (Year): 59 (2012)
Issue (Month): 8 ()
Pages: 751-768

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Handle: RePEc:eee:moneco:v:59:y:2012:i:8:p:751-768

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

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Cited by:
  1. Yu, Jihai & Zhu, Guozhong, 2013. "How uncertain is household income in China," Economics Letters, Elsevier, vol. 120(1), pages 74-78.
  2. Marekwica, Marcel & Schaefer, Alexander & Sebastian, Steffen, 2013. "Life cycle asset allocation in the presence of housing and tax-deferred investing," Journal of Economic Dynamics and Control, Elsevier, vol. 37(6), pages 1110-1125.

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