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Collateralized borrowing and life-cycle portfolio choice

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Listed author(s):
  • Paul S. Willen
  • Felix Kubler

Abstract

We examine the effects of collateralized borrowing in a realistically parameterized life-cycle portfolio choice problem. We provide basic intuition in a two-period model and then solve a multi-period model computationally. Our analysis provides insights into life-cycle portfolio choice relevant for researchers in macroeconomics and finance. In particular, we show that standard models with unlimited borrowing at the riskless rate dramatically overstate the gains to holding equity when compared with collateral-constrained models. Our results do not depend on the specification of the collateralized borrowing regime: The gains to trading equity remain relatively small even with the unrealistic assumption of unlimited leverage. We argue that our results strengthen the role of borrowing constraints in explaining the portfolio participation puzzle, that is, why most investors do not own stock.

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Paper provided by Federal Reserve Bank of Boston in its series Public Policy Discussion Paper with number 06-4.

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Date of creation: 2006
Handle: RePEc:fip:fedbpp:06-4
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Keywords: Margin accounts ; Investments ; Securities;

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Find related papers by JEL classification:
  • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
  • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance

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  1. Steven J. Davis & Felix Kubler & Paul Willen, 2006. "Borrowing Costs and the Demand for Equity over the Life Cycle," The Review of Economics and Statistics, MIT Press, vol. 88(2), pages 348-362, May.
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Cited by:

  1. Magnus Henrekson & Tino Sanandaji, 2011. "Entrepreneurship and the theory of taxation," Small Business Economics, Springer, vol. 37(2), pages 167-185, September.
  2. Andreas Fuster & Paul S. Willen, 2011. "Insuring Consumption Using Income-Linked Assets," Review of Finance, European Finance Association, vol. 15(4), pages 835-873.
  3. Roche, Hervé & Tompaidis, Stathis & Yang, Chunyu, 2013. "Why does junior put all his eggs in one basket? A potential rational explanation for holding concentrated portfolios," Journal of Financial Economics, Elsevier, vol. 109(3), pages 775-796.
  4. Raffaele Miniaci & Sergio Pastorello, 2010. "Mean-variance econometric analysis of household portfolios," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(3), pages 481-504.
  5. Ian Ayres & Barry J. Nalebuff, 2008. "Life-cycle Investing and Leverage: Buying Stock on Margin Can Reduce Retirement Risk," NBER Working Papers 14094, National Bureau of Economic Research, Inc.

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