Labor Income and the Demand for Long-term Bonds
AbstractThe riskless nature in real terms of inflation-linked bonds has led to the conclusion that inflation-linked bonds should constitute a substantial part of the optimal investment portfolio of long-term investors.This conclusion is reached in models where investors do not receive labor income during the investment period.Since such an income stream is often indexed with inflation, labor income in itself constitutes an implicit holding of real bonds.As such, the optimal investment in inflation-linked bonds is substantially reduced.By extending recently developed simulation-based techniques, we are able to determine the optimal portfolio choice among inflation-linked bonds, nominal bonds, and stocks for investors endowed with an indexed stream of income.We find that the fraction invested in inflation-linked bonds is much smaller than reported in the literature, the duration of the optimal nominal bond portfolio is lengthened, and the utility gains of having access to inflation-linked bonds are substantially reduced.We investigate as well the robustness of our results to time-variation in bond risk premia, the riskiness of labor income, and correlation between labor income risk and financial risks.We find that especially accounting for time-variation in bond risk premia and correlation between labor income risk and financial risks is important for both optimal portfolios and the utility gains of having access to inflation-linked bonds.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2005-95.
Date of creation: 2005
Date of revision:
Contact details of provider:
Web page: http://center.uvt.nl
inflation linked bonds; optimal lifetime investment; simulation-based portfolio choice;
Find related papers by JEL classification:
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-09-29 (All new papers)
- NEP-CMP-2005-09-29 (Computational Economics)
- NEP-FIN-2005-09-29 (Finance)
- NEP-MAC-2005-09-29 (Macroeconomics)
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- 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.
- Frank de Jong, 2005.
"Valuation of pension liabilities in incomplete markets,"
DNB Working Papers
067, Netherlands Central Bank, Research Department.
- De Jong, Frank, 2008. "Valuation of pension liabilities in incomplete markets," Journal of Pension Economics and Finance, Cambridge University Press, vol. 7(03), pages 277-294, November.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Richard Broekman).
If references are entirely missing, you can add them using this form.