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Unemployment and Portfolio Choice: Does Persistence Matter?

Author Info

Listed author(s):
  • Vladimir Kuzin
  • Franziska Bremus

Abstract

We use a life cycle model of consumption and portfolio choice to study the effects of social security on the investment decisions of households for the European case. Our model is mainly based on the one developed by Cocco, Gomes, and Maenhout (2005). We extend it by unemployment risk using Markov chains to model the transition between different employment states. In contrast to most models in the life cycle literature, our model allows for three different states, namely employment, short-term as well as long-term unemployment. This allows us to examine the effects of persistence in the unemployment process on portfolio choice. Our main findings are, first, that in case of short-term unemployment only, social security systems as those established in the EU are able to offset the negative impact of unemployment risk on the portfolio-share invested in risky assets. Second, the simulation results reveal that when allowing for long-term unemployment the equity-share is suppressed, especially for young investors. We show that this negative effect of unemployment is mainly driven by its persistence.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.347770.de/dp978.pdf
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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 978.

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Length: 25 p.
Date of creation: 2010
Handle: RePEc:diw:diwwpp:dp978
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Keywords: Precautionary savings; unemployment insurance; long-term unemployment; income uncertainty;

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Find related papers by JEL classification:
  • D91 - Microeconomics - - Intertemporal Choice - - - Intertemporal Household Choice; Life Cycle Models and Saving
  • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
  • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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  1. Christopher D. Carroll, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 1-55.
  2. Luca Benzoni & Pierre Collin-Dufresne & Robert S. Goldstein, 2007. "Portfolio Choice over the Life-Cycle when the Stock and Labor Markets Are Cointegrated," Journal of Finance, American Finance Association, vol. 62(5), pages 2123-2167, October.
  3. Ayse Imrohoroglu & Selahattin Imrohoroglu & Douglas H. Joines, 1999. "Social Security in an Overlapping Generations Economy with Land," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(3), pages 638-665, July.
  4. Francisco Gomes & Alexander Michaelides, 2003. "Portfolio Choice With Internal Habit Formation: A Life-Cycle Model With Uninsurable Labor Income Risk," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 729-766, October.
  5. Raimond Maurer & Olivia S. Mitchell & Ralph Rogalla, 2010. "The Effect of Uncertain Labor Income and Social Security on Life-cycle Portfolios," NBER Working Papers 15682, National Bureau of Economic Research, Inc.
  6. Valery Polkovnichenko, 2007. "Life-Cycle Portfolio Choice with Additive Habit Formation Preferences and Uninsurable Labor Income Risk," Review of Financial Studies, Society for Financial Studies, vol. 20(1), pages 83-124, January.
  7. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
  8. Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1996. "Income Risk, Borrowing Constraints, and Portfolio Choice," American Economic Review, American Economic Association, vol. 86(1), pages 158-172, March.
  9. Pierre-Olivier Gourinchas & Jonathan A. Parker, 2002. "Consumption Over the Life Cycle," Econometrica, Econometric Society, vol. 70(1), pages 47-89, January.
  10. Elke Holst & Dean R. Lillard & Thomas A. DiPrete, 2001. "Proceedings of the 2000 Fourth International Conference of German Socio-Economic Panel Study Users (GSOEP 2000): Editorial Introduction," Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Economic Research, DIW Berlin, German Institute for Economic Research, vol. 70(1), pages 5-6.
  11. Joao F. Cocco, 2005. "Consumption and Portfolio Choice over the Life Cycle," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 491-533.
  12. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
  13. Bodie, Zvi & Merton, Robert C. & Samuelson, William F., 1992. "Labor supply flexibility and portfolio choice in a life cycle model," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 427-449.
  14. Carroll, Christopher D., 2006. "The method of endogenous gridpoints for solving dynamic stochastic optimization problems," Economics Letters, Elsevier, vol. 91(3), pages 312-320, June.
  15. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-257, August.
  16. Imrohoroglu, Ayse & Imrohoroglu, Selahattin & Joines, Douglas H, 1995. "A Life Cycle Analysis of Social Security," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 6(1), pages 83-114, June.
  17. Sánchez Martín, A. & Jiménez Martín, S. & Robalino, D. & Todeschini, F., 2012. "Labor Income and the Design of Default Portfolios in Mandatory Pension Systems: An Application to Chile," Working Papers 2012-04, FEDEA.
  18. Carroll, Christopher D. & Samwick, Andrew A., 1997. "The nature of precautionary wealth," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 41-71, September.
  19. Engen, Eric M. & Gruber, Jonathan, 2001. "Unemployment insurance and precautionary saving," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 545-579, June.
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Cited by:

  1. Philip Müller, 2016. "Poverty in Europe: Sociodemographics, Portfolios and Consumption of Wealth Poor Households," LWS Working papers 22, LIS Cross-National Data Center in Luxembourg.

This item is featured on the following reading lists or Wikipedia pages:

  1. Unemployment and portfolio choice: Does persistence matter? (Journal of Macroeconomics 2014) in ReplicationWiki

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