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Hedging Labor Income Risk over the Life-Cycle

Author

Listed:
  • Fabio C. Bagliano
  • Raffaele Corvino
  • Carolina Fugazza
  • Giovanna Nicodano

Abstract

We show that the decision to participate in the stock market depends on the ability of equities to hedge the individual permanent earnings shocks, consistent with implications of life-cycle models. Those households who refrain from stock investing display positive correlation between their own permanent income innovations and market returns. These results owe to a two-step empirical strategy. First, a minimum distance estimation disentangles the aggregate from the idiosyncratic permanent component of labor income risks. The second step reconstructs the individual life-cycle dynamics of persistent shocks through a Kalman filter applied to the estimated labor income process. We are thus able to obtain the full cross-sectional distribution of individual correlations between permanent shocks and market returns.

Suggested Citation

  • Fabio C. Bagliano & Raffaele Corvino & Carolina Fugazza & Giovanna Nicodano, 2018. "Hedging Labor Income Risk over the Life-Cycle," Carlo Alberto Notebooks 576, Collegio Carlo Alberto.
  • Handle: RePEc:cca:wpaper:576
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    References listed on IDEAS

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    More about this item

    Keywords

    Stock market participation; Labor income-risk return correlation; Permanent income shocks; Kalman filter.;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General

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