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Precautionary saving and portfolio allocation: DP by GMM

  • Marc-Andre Letendre


    (McMaster University)

  • Gregor Smith


    (Queen's University)

There is much research on consumption-savings problems with risky labor income and a constant interest rate and also on portfolio allocation with risky returns but nonstochastic labor income. Less is known quantitatively about the interaction between the two forms of risk. Under CRRA utility, undiversifiable income risk should be reflected in both savings rates and portfolio allocations. To quantify these effects in a model of consumption and portfolio choice, we adopt a semi-parametric projection method for solving dynamic programmes, based on generalized method of moments estimation of the parameters of approximate decision rules. We find that background income risk does affect optimal portfolios but that this effect may be difficult to detect empirically.

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Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1247.

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Length: 25 pages
Date of creation: Aug 2000
Date of revision:
Publication status: forthcoming in the Journal of Monetary Economics
Handle: RePEc:qed:wpaper:1247
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