We investigate optimal consumption, asset accumulation and portfolio decisions in a realistically calibrated life-cycle model with flexible labor supply. Our framework allows for wage rate uncertainly, variable labor supply, social security benefits and portfolio choice over safe bonds and risky equities. Our analysis reinforces prior findings that equities are the preferred asset for young households, with the optimal share of equities generally declining prior to retirement. However, variable labor materially alters pre-retirement portfolio choice by significantly raising optimal equity holdings. Using this model, we also investigate the welfare costs of constraining portfolio allocations over the life cycle to mimic popular default investment choices in defined-contribution pension plans, such as stable value funds, balanced funds, and life-cycle (or target date) funds. We find that life-cycle funds designed to match the risk tolerance and investment horizon of investors have small welfare costs. All other choices, including life-cycle funds which do not match investors' risk tolerance, can have substantial welfare costs.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13966.
Length: Date of creation: Apr 2008 Date of revision: Handle: RePEc:nbr:nberwo:13966
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Eugene F. Fama & Kenneth R. French, 2002.
"The Equity Premium,"
Journal of Finance,
American Finance Association, vol. 57(2), pages 637-659, 04.
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Other versions:
Eugene Fama & F. & Kenneth R. French, .
"The Equity Premium.","
CRSP working papers
522, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Juergen Jung, 2008.
"The Timing of Redistribution,"
Caepr Working Papers
2008-015, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
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