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Consumption Smoothing and Portfolio Rebalancing: The Effects of Adjustment Costs

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  • Yosef Bonaparte
  • Russell Cooper
  • Guozhong Zhu

Abstract

This paper studies the dynamics of portfolio rebalancing and consumption smoothing in the presence of non-convex portfolio adjustment costs. The goal is to understand a household's response to income and return shocks. The model includes the choice of two assets: one riskless without adjustment costs and a second risky asset with adjustment costs. With these multiple assets, a household can buffer some income fluctuations through the asset without adjustment costs and engage in costly portfolio rebalancing less frequently. We estimate both preference parameters and portfolio adjustment costs. The estimates are used for evaluating consumption smoothing and portfolio adjustment in the face of income and return shocks.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16957.

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Date of creation: Apr 2011
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Handle: RePEc:nbr:nberwo:16957

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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.

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