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Optimal life-cycle portfolios for heterogeneous workers

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  • Fabio C. Bagliano
  • Carolina Fugazza
  • Giovanna Nicodano

Abstract

Household portfolios include risky bonds, beyond stocks, and respond to permanent labour income shocks. This paper brings these features into a life-cycle setting, and shows that optimal stock investment is constant or increasing in age before retirement for realistic parameter combinations. The driver of such inversion in the life-cycle profile is the resolution of uncertainty regarding social security pension, which increases the investor'srisk appetite. This occurs if a small positive contemporaneous correlation between permanent labour income shocks and stock returns is matched by a realistically high variance of such shocks and/or risk aversion. Absent this combination, the typical downward sloping profile obtains. Overlooking differences in optimal investment profiles across heterogeneous workers results in large welfare losses, in the order of 15-30% of lifetime consumption.

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Bibliographic Info

Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 266.

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Length: 46 pages
Date of creation: 2012
Date of revision: 2013
Handle: RePEc:cca:wpaper:266

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Keywords: Life-cycle portfolio choice; background risk; age rule; investor heterogeneity; stock market participation;

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