Human Capital as an Asset Mix and Optimal Life-Cycle Portfolio: An Analytical Solution
AbstractThis study examines life-cycle optimal consumption and asset allocation in the presence of human capital. Labor income seems like a "money market mutual fund" whose balance in one or two years is predictable but a wide dispersion results after many years, reflecting fluctuations in economic conditions. We use the Martingale method to derive an analytical solution, finding that Merton's well-known " constant-mix strategy" is still true after incorporating human capital from the perspective of "total wealth" management. Moreover, the proportion in risky assets implicit in the agent's human capital is the main factor determining the optimal investment strategy. The numerical examples suggest that young investors should short stocks because their human capital has large market exposure. As they age, however, their human capital becomes "bond-like", and thus they have to hold stocks to achieve optimal overall risk exposure.
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Bibliographic InfoPaper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-565.
Length: 34 pages
Date of creation: Jun 2008
Date of revision:
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-06-13 (All new papers)
- NEP-DGE-2008-06-13 (Dynamic General Equilibrium)
- NEP-HRM-2008-06-13 (Human Capital & Human Resource Management)
- NEP-MAC-2008-06-13 (Macroeconomics)
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