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Life-Cycle Portfolio Choice: The Role of Heterogeneity and Under-diversification

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Author Info
Claudio Campanale () (Universidad de Alicante)

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Abstract

The empirical work on household portfolio choice documents two facts. One, the stock market participation rate is low and hump-shaped over the life-cycle, two, the conditional share of stocks is also low but does not appear to change much during the life-cycle. In contrast the standard life-cycle portfolio choice model predicts high and monotonically increasing participation rates and conditional stock shares that are low and exhibit dramatic changes with age. In this paper I consider a number of extensions to this basic framework. I find that a small per period participation cost is needed to generate a hump shaped life-cycle profile of participation rates. Under a realistic calibration the quantitative effect is minor. Progressive social security and the assumption that the risk of stock portfolios is declining in household wealth as a consequence of better diversification opportunities 'an assumption that has some empirical support' though provide substantial amplification and significantly improve the ability of the model to match the data. Under-diversification also reduces the average portfolio share of stocks conditional on participation and, together with the intergenerational transmission of wealth makes it insensitive to age, consistent with the empirical evidence.

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Paper provided by Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) in its series Working Papers. Serie AD with number 2008-06.

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Length: 44 pages
Date of creation: Mar 2008
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Publication status: Published by Ivie
Handle: RePEc:ivi:wpasad:2008-06

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Keywords: Portfolio choice; life-cycle; bequests; diversification; social security.;

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References listed on IDEAS
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