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Precautionary saving and portfolio allocation: DP by GMM

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  • Marc-Andre Letendre

    ()
    (McMaster University)

  • Gregor Smith

    ()
    (Queen's University)

Abstract

There is much research on consumption-savings problems with risky labor income and a constant interest rate and also on portfolio allocation with risky returns but nonstochastic labor income. Less is known quantitatively about the interaction between the two forms of risk. Under CRRA utility, undiversifiable income risk should be reflected in both savings rates and portfolio allocations. To quantify these effects in a model of consumption and portfolio choice, we adopt a semi-parametric projection method for solving dynamic programmes, based on generalized method of moments estimation of the parameters of approximate decision rules. We find that background income risk does affect optimal portfolios but that this effect may be difficult to detect empirically.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1247.pdf
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1247.

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Length: 25 pages
Date of creation: Aug 2000
Date of revision:
Publication status: forthcoming in the Journal of Monetary Economics
Handle: RePEc:qed:wpaper:1247

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Keywords: portfolio theory; precautionary saving;

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References

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Cited by:
  1. Luis M. Viceira, 2001. "Optimal Portfolio Choice for Long-Horizon Investors with Nontradable Labor Income," Journal of Finance, American Finance Association, vol. 56(2), pages 433-470, 04.
  2. Jaime Ruiz-Tagle, 2006. "Financial Markets Incompleteness and Inequality Over the Life-Cycle," Working Papers Central Bank of Chile, Central Bank of Chile 405, Central Bank of Chile.
  3. repec:hal:wpaper:halshs-00588069 is not listed on IDEAS
  4. Wilson, Bonnie, 2003. "Diversification of risk and saving," The Quarterly Review of Economics and Finance, Elsevier, vol. 43(4), pages 697-712.
  5. M-A. Letendre, 2002. "Semi-Parametric Predictions of the Intertemporal Approach to the Current Account," Department of Economics Working Papers 2002-01, McMaster University.
  6. Sule Alan, 2004. "Precautionary Wealth and Portfolio Allocation: Evidence from Canadian Microdata," Social and Economic Dimensions of an Aging Population Research Papers 117, McMaster University.
  7. Veld-Merkoulova, Yulia V., 2011. "Investment horizon and portfolio choice of private investors," International Review of Financial Analysis, Elsevier, vol. 20(2), pages 68-75, April.
  8. Luc Arrondel & Hector Calvo Pardo & Xisco Oliver, 2007. "Temperant portfolio choice and background risk: evidence from France," PSE Working Papers halshs-00588069, HAL.
  9. Feigenbaum, James, 2005. "Second-, third-, and higher-order consumption functions: a precautionary tale," Journal of Economic Dynamics and Control, Elsevier, vol. 29(8), pages 1385-1425, August.

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