IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Optimal Portfolio Choice for Long-Horizon Investors with Nontradable Labor Income

  • Luis M. Viceira

This paper analyzes optimal portfolio decisions of long-horizon investors with undiversifiable labor income risk and exogenous expected retirement and lifetime horizons. It shows that the fraction of savings optimally invested in stocks is unambiguously larger for employed investors than for retired investors when labor income risk is uncorrelated with stock return risk. This result provides support for the popular recommendation by investment advisors that employed investors should invest in stocks a larger proportion of their savings than retired investors. This paper also examines the effect of increasing labor income risk on savings and portfolio choice and finds that, when labor income risk is independent of stock market risk, a mean-preserving increases in the variance of labor income growth increases the investor's willingness to save and reduce her willingness to hold the risky asset in her portfolio. A sensible calibration of the model shows that savings are relatively more responsive to changes in labor income risk than portfolio demands. Positive correlation between labor income innovations and unexpected asset returns also reduces the investor's willingness to hold the risky asset, because of its poor properties as a hedge against unexpected declines in labor income. This paper also provides intuition on the peculiar form of optimal portfolio choice of very young investors predicted by the standard life-cycle model.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.nber.org/papers/w7409.pdf
Download Restriction: no

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7409.

as
in new window

Length:
Date of creation: Oct 1999
Publication status: published as Viceira, Luis M. "Optimal Portfolio Choice For Long-Horizon Investors With Nontradable Labor Income," Journal of Finance, 2001, v56(2,Apr), 433-470.
Handle: RePEc:nbr:nberwo:7409
Note: AP
Contact details of provider: Postal:
National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.

Phone: 617-868-3900
Web page: http://www.nber.org
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Douglas W. Elmendorf & Miles S. Kimball, "undated". "Taxation of Labor Income and the Demand for Risky Assets," Finance and Economics Discussion Series 1996-32, Board of Governors of the Federal Reserve System (U.S.).
  2. Marc-Andre Letendre & Gregor Smith, 2000. "Precautionary saving and portfolio allocation: DP by GMM," Working Papers 1247, Queen's University, Department of Economics.
  3. Stephen P. Zeldes, . "Consumption and Liquidity Constraints: An Empirical Investigation," Rodney L. White Center for Financial Research Working Papers 16-88, Wharton School Rodney L. White Center for Financial Research.
  4. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, vol. 18(1), pages 83-114, January.
  5. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. John Y. Campbell & Joao Cocco & Francisco Gomes & Pascal Maenhout & Luis M. Viceira, 1999. "Stock Market Mean Reversion and the Optimal Equity Allocation of a Long-Lived Investor," Computing in Economics and Finance 1999 1344, Society for Computational Economics.
  7. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  8. John Y. CAMPBELL & Luis VICEIRA, 1998. "Who Should Buy Long-Term Bonds?," FAME Research Paper Series rp5, International Center for Financial Asset Management and Engineering.
  9. repec:ete:ceswps:ces9805 is not listed on IDEAS
  10. Christopher D. Carroll, 1996. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," NBER Working Papers 5788, National Bureau of Economic Research, Inc.
  11. Heaton, John & Lucas, Deborah, 1997. "Market Frictions, Savings Behavior, And Portfolio Choice," Macroeconomic Dynamics, Cambridge University Press, vol. 1(01), pages 76-101, January.
  12. Gourinchas, Pierre-Olivier & Parker, Jonathan A, 2000. "Consumption Over the Life-Cycle," CEPR Discussion Papers 2345, C.E.P.R. Discussion Papers.
  13. Campbell, John, 1993. "Intertemporal Asset Pricing Without Consumption Data," Scholarly Articles 3221491, Harvard University Department of Economics.
  14. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
  15. Campbell, John & Viceira, Luis, 1999. "Consumption and Portfolio Decisions When Expected Returns are Time Varying," Scholarly Articles 3163266, Harvard University Department of Economics.
  16. Abowd, John M & Card, David, 1989. "On the Covariance Structure of Earnings and Hours Changes," Econometrica, Econometric Society, vol. 57(2), pages 411-45, March.
  17. Gertler, Mark, 1997. "Government Debt and Social Security in a Life-Cycle Economy," Working Papers 97-14, C.V. Starr Center for Applied Economics, New York University.
  18. Deaton, A., 1989. "Saving And Liquidity Constraints," Papers 153, Princeton, Woodrow Wilson School - Public and International Affairs.
  19. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  20. Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1994. "Income Risk, Borrowing Constraints and Portfolio Choice," CEPR Discussion Papers 888, C.E.P.R. Discussion Papers.
  21. Fama, Eugene F. & Schwert, G. William, 1977. "Human capital and capital market equilibrium," Journal of Financial Economics, Elsevier, vol. 4(1), pages 95-125, January.
  22. George M. Constantinidies & John B. Donaldson & Rajnish Mehra, 1998. "Junior Can't Borrow: A New Perspective on the Equity Premium Puzzle," NBER Working Papers 6617, National Bureau of Economic Research, Inc.
  23. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May.
  24. Paul A. Samuelson, 2011. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," World Scientific Book Chapters, in: THE KELLY CAPITAL GROWTH INVESTMENT CRITERION THEORY and PRACTICE, chapter 31, pages 465-472 World Scientific Publishing Co. Pte. Ltd..
  25. Canner, Niko & Mankiw, N Gregory & Weil, David N, 1997. "An Asset Allocation Puzzle," American Economic Review, American Economic Association, vol. 87(1), pages 181-191, March.
  26. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-247, April.
  27. repec:cup:macdyn:v:1:y:1997:i:1:p:76-101 is not listed on IDEAS
  28. Zvi Bodie & Robert C. Merton & William F. Samuelson, 1992. "Labor Supply Flexibility and Portfolio Choice in a Life-Cycle Model," NBER Working Papers 3954, National Bureau of Economic Research, Inc.
  29. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, vol. 55(1), pages 143-54, January.
  30. Christopher D. Carroll & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
  31. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  32. Svensson, Lars E. O. & Werner, Ingrid M., 1993. "Nontraded assets in incomplete markets : Pricing and portfolio choice," European Economic Review, Elsevier, vol. 37(5), pages 1149-1168, June.
  33. Carroll, Christopher D & Kimball, Miles S, 1996. "On the Concavity of the Consumption Function," Econometrica, Econometric Society, vol. 64(4), pages 981-92, July.
  34. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, Enero.
  35. John Heaton & Deborah Lucas, 2000. "Portfolio Choice and Asset Prices: The Importance of Entrepreneurial Risk," Journal of Finance, American Finance Association, vol. 55(3), pages 1163-1198, 06.
  36. Wouter J. Den Haan & Albert Marcet, 1994. "Accuracy in Simulations," Review of Economic Studies, Oxford University Press, vol. 61(1), pages 3-17.
  37. EECKHOUDT, Louis & Christian GOLLIER & Harris SCHLESINGER, 1994. "Changes in Background Risk and Risk Taking Behavior," Working Papers 005, Risk and Insurance Archive.
  38. Gollier, Christian & Pratt, John W, 1996. "Risk Vulnerability and the Tempering Effect of Background Risk," Econometrica, Econometric Society, vol. 64(5), pages 1109-23, September.
  39. Miles S. Kimball, 1990. "Precautionary Saving and the Marginal Propensity to Consume," NBER Working Papers 3403, National Bureau of Economic Research, Inc.
  40. Weil, Philippe, 1994. "Nontraded assets and the CAPM," European Economic Review, Elsevier, vol. 38(3-4), pages 913-922, April.
  41. Ravi Jagannathan & Narayana R. Kocherlakota, 1996. "Why should older people invest less in stock than younger people?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 11-23.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:7409. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.