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Collateralized borrowing and life-cycle portfolio choice

  • Paul Willen
  • Felix Kubler

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
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Handle: RePEc:fip:fedbpp:06-4
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