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When Can Life Cycle Investors Benefit from Time-Varying Bond Risk Premia?

Author

Listed:
  • Ralph S. J. Koijen
  • Theo E. Nijman
  • Bas J. M. Werker

Abstract

We study the importance of time-varying bond risk premia in a consumption and portfolio-choice problem for a life-cycle investor facing short-sales and borrowing constraints. Tilts in the optimal asset allocation in response to changes in bond risk premia exhibit pronounced life-cycle patterns. We find that the investor is willing to pay an annual fee up to 1% to implement a strategy that optimally conditions on prevailing bond risk premia in addition to her age and wealth. To solve our model, we extend recently developed simulation-based techniques to life-cycle problems featuring multiple state variables and multiple risky assets. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

Suggested Citation

  • Ralph S. J. Koijen & Theo E. Nijman & Bas J. M. Werker, 2010. "When Can Life Cycle Investors Benefit from Time-Varying Bond Risk Premia?," Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 741-780, February.
  • Handle: RePEc:oup:rfinst:v:23:y:2010:i:2:p:741-780
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    File URL: http://hdl.handle.net/10.1093/rfs/hhp058
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    Cited by:

    1. Otto Van Hemert, 2010. "Household Interest Rate Risk Management," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 38(3), pages 467-505.
    2. Koijen, Ralph S.J. & Hemert, Otto Van & Nieuwerburgh, Stijn Van, 2009. "Mortgage timing," Journal of Financial Economics, Elsevier, vol. 93(2), pages 292-324, August.
    3. Fugazza, Carolina & Giofré, Maela & Nicodano, Giovanna, 2011. "International diversification and industry-related labor income risk," International Review of Economics & Finance, Elsevier, vol. 20(4), pages 764-783, October.
    4. Ferstl, Robert & Weissensteiner, Alex, 2011. "Asset-liability management under time-varying investment opportunities," Journal of Banking & Finance, Elsevier, vol. 35(1), pages 182-192, January.
    5. Aglietta, Michel & Brière, Marie & Rigot, Sandra & Signori, Ombretta, 2012. "Rehabilitating the role of active management for pension funds," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2565-2574.
    6. Huang, Huaxiong & Milevsky, Moshe A., 2016. "Longevity risk and retirement income tax efficiency: A location spending rate puzzle," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 50-62.
    7. Nick Draper & Casper Ewijk & Marcel Lever & Roel Mehlkopf, 2014. "Stochastic Generational Accounting Applied to Reforms of Dutch Occupational Pensions," De Economist, Springer, vol. 162(3), pages 287-307, September.
    8. Christensen, Peter Ove & Larsen, Kasper & Munk, Claus, 2012. "Equilibrium in securities markets with heterogeneous investors and unspanned income risk," Journal of Economic Theory, Elsevier, vol. 147(3), pages 1035-1063.
    9. Björn Bick & Holger Kraft & Claus Munk, 2013. "Solving Constrained Consumption-Investment Problems by Simulation of Artificial Market Strategies," Management Science, INFORMS, vol. 59(2), pages 485-503, June.
    10. Bütler, Monika & Peijnenburg, Kim & Staubli, Stefan, 2017. "How much do means-tested benefits reduce the demand for annuities?," Journal of Pension Economics and Finance, Cambridge University Press, vol. 16(04), pages 419-449, October.
    11. Kim Peijnenburg, 2014. "Life-Cycle Asset Allocation with Ambiguity Aversion and Learning," 2014 Meeting Papers 967, Society for Economic Dynamics.
    12. Kees de Van & Daniele Fano & Herialt Mens & Giovanna Nicodano, 2014. "A Reporting Standard for Defined Contribution Pension Plans," CeRP Working Papers 143, Center for Research on Pensions and Welfare Policies, Turin (Italy).
    13. Larsen, Linda Sandris & Munk, Claus, 2012. "The costs of suboptimal dynamic asset allocation: General results and applications to interest rate risk, stock volatility risk, and growth/value tilts," Journal of Economic Dynamics and Control, Elsevier, vol. 36(2), pages 266-293.
    14. Thomas Post & Helmut Gründl & Joan T. Schmit & Anja Zimmer, 2014. "The Impact of Investment Behaviour for Individual Welfare," Economica, London School of Economics and Political Science, vol. 81(321), pages 15-47, January.
    15. Li, Minqiang, 2010. "Asset Pricing - A Brief Review," MPRA Paper 22379, University Library of Munich, Germany.
    16. Peijnenburg, Kim & Nijman, Theo & Werker, Bas J.M., 2016. "The annuity puzzle remains a puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 70(C), pages 18-35.
    17. Alserda, G.A.G. & Steenbeek, O.W. & van der Lecq, S.G., 2017. "The Occurrence and Impact of Pension Fund Discontinuity," ERIM Report Series Research in Management ERS-2017-008-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.

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