Portfolio Choice, Liquidity Constraints and Stock Market Mean Reversion
AbstractThis paper solves numerically for the optimal consumption and portfolio choice of an infinitely lived investor facing short-sales and borrowing constraints, undiversifiable labor income risk and a predictable time varying equity premium. The investor aggressively times the market while positive correlation between permanent earnings shocks and stock return innovations generates a substantial hedging demand for the riskless asset. Moreover, a speculative increase in savings arises when stock returns are expected to be high and conversely when future returns are expected to be low. Small information/optimization costs can make it optimal for an investor to assume i.i.d. excess stock returns both because liquidity constraints can be frequently binding and because households can smooth idiosyncratic earnings shocks using a small buffer stock of wealth.
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Bibliographic InfoPaper provided by Society for Computational Economics in its series Computing in Economics and Finance 2001 with number 115.
Date of creation: 01 Apr 2001
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Web page: http://www.econometricsociety.org/conference/SCE2001/SCE2001.html
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Portfolio Choice; Liquidity Constraints; Buffer Stock Saving; Stock Market Mean Reversion; Stock Market Predictability;
Other versions of this item:
- Michaelides, Alexander, 2001. "Portfolio Choice, Liquidity Constraints and Stock Market Mean Reversion," CEPR Discussion Papers 2823, C.E.P.R. Discussion Papers.
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
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- Michael Haliassos & Alexandros Michaelides, 1999.
"Portfolio Choice and Liquidity Constraints,"
University of Cyprus Working Papers in Economics
9918, University of Cyprus Department of Economics.
- Michael Haliassos, Alexander Michaelides, 2000. "Portfolio Choice And Liquidity Constraints," Computing in Economics and Finance 2000 297, Society for Computational Economics.
- Haliassos, Michalis & Michaelides, Alexander, 2001. "Portfolio Choice and Liquidity Constraints," CEPR Discussion Papers 2822, C.E.P.R. Discussion Papers.
- Luca Benzoni & Pierre Collin-Dufresne & Robert S. Goldstein, 2007. "Portfolio choice over the life-cycle when the stock and labor markets are cointegrated," Working Paper Series WP-07-11, Federal Reserve Bank of Chicago.
- Anthony W. Lynch & Sinan Tan, 2004. "Labor Income Dynamics at Business-Cycle Frequencies: Implications for Portfolio Choice," NBER Working Papers 11010, National Bureau of Economic Research, Inc.
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