IDEAS home Printed from https://ideas.repec.org/p/zbw/arqudp/323203.html
   My bibliography  Save this paper

Life cycle consumption and portfolio choice under real interest rate risk

Author

Listed:
  • Fischer, Marcel
  • Jankowski, Natascha

Abstract

We set up a life cycle model with real interest rate risk to demonstrate that real interest rates have implications for optimal household consumption and investments. Lower interest rates lead to higher optimal stock investments and lower consumption. Ignoring the time-varying nature of real interest rates leads to overconsumption and underinvestment into stocks when interest rates are high and, ultimately, substantial welfare costs. Being exposed to an extended period of low interest rates even leads to substantial welfare losses when behaving optimally - particularly when being exposed to it at around retirement age when savings peak.

Suggested Citation

  • Fischer, Marcel & Jankowski, Natascha, 2025. "Life cycle consumption and portfolio choice under real interest rate risk," arqus Discussion Papers in Quantitative Tax Research 291, arqus - Arbeitskreis Quantitative Steuerlehre.
    • Handle: RePEc:zbw:arqudp:323203
    as

    Download full text from publisher

    File URL: https://www.econstor.eu/bitstream/10419/323203/1/1931359962.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    2. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    3. Sylvain Catherine, 2022. "Countercyclical Labor Income Risk and Portfolio Choices over the Life Cycle," The Review of Financial Studies, Society for Financial Studies, vol. 35(9), pages 4016-4054.
    4. Michael Weber & Yuriy Gorodnichenko & Olivier Coibion, 2023. "The Expected, Perceived, and Realized Inflation of US Households Before and During the COVID19 Pandemic," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 71(1), pages 326-368, March.
    5. Lamla, Michael J. & Vinogradov, Dmitri V., 2019. "Central bank announcements: Big news for little people?," Journal of Monetary Economics, Elsevier, vol. 108(C), pages 21-38.
    6. Meh, Césaire A. & Ríos-Rull, José-Víctor & Terajima, Yaz, 2010. "Aggregate and welfare effects of redistribution of wealth under inflation and price-level targeting," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 637-652, September.
    7. Paul Beaudry & Katya Kartashova & Césaire Meh, 2024. "Asset Demand and Real Interest Rates," NBER Working Papers 32248, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. David Backus & Mikhail Chernov & Stanley Zin, 2014. "Sources of Entropy in Representative Agent Models," Journal of Finance, American Finance Association, vol. 69(1), pages 51-99, February.
    2. A Craig Burnside & Jeremy J Graveline, 2020. "On the Asset Market View of Exchange Rates," The Review of Financial Studies, Society for Financial Studies, vol. 33(1), pages 239-260.
    3. Duffie, Darrell, 2003. "Intertemporal asset pricing theory," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 11, pages 639-742, Elsevier.
    4. Michael Weber & Francesco D'Acunto & Yuriy Gorodnichenko & Olivier Coibion, 2022. "The Subjective Inflation Expectations of Households and Firms: Measurement, Determinants, and Implications," Journal of Economic Perspectives, American Economic Association, vol. 36(3), pages 157-184, Summer.
    5. Michael Hatcher, 2013. "Aggregate and welfare effects of long run inflation risk under inflation and price-level targeting," Working Papers 2013_03, Business School - Economics, University of Glasgow.
    6. Juan Carlos Hatchondo & Leonardo Martinez & César Sosa-Padilla, 2016. "Debt Dilution and Sovereign Default Risk," Journal of Political Economy, University of Chicago Press, vol. 124(5), pages 1383-1422.
    7. repec:dau:papers:123456789/5374 is not listed on IDEAS
    8. Jean-Paul Décamps, 1993. "Valorisation de produits obligataires dans un modéle d'équilibre général en temps discret," Annals of Economics and Statistics, GENES, issue 31, pages 73-100.
    9. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, August.
    10. Li, Kai & Liu, Jun, 2023. "Extrapolative asset pricing," Journal of Economic Theory, Elsevier, vol. 210(C).
    11. Vanya Horneff & Raimond Maurer & Olivia S. Mitchell, 2023. "Fixed and variable longevity income annuities in defined contribution plans: Optimal retirement portfolios taking social security into account," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 90(4), pages 831-860, December.
    12. Han, Nan-Wei & Hung, Mao-Wei, 2017. "Optimal consumption, portfolio, and life insurance policies under interest rate and inflation risks," Insurance: Mathematics and Economics, Elsevier, vol. 73(C), pages 54-67.
    13. Frederick van der Ploeg & Johannes Emmerling & Ben Groom, 2023. "The Social Cost of Carbon with Intragenerational Inequality and Economic Uncertainty," Discussion Papers 2301, University of Exeter, Department of Economics.
    14. Jing Yuan & Yan Peng & Zongwu Cai & Zhengyi Zhang, 2021. "A Quantitative Evaluation to Interest Rate Marketization Reform in China," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 202122, University of Kansas, Department of Economics.
    15. Peter Smith & Michael Wickens, 2002. "Asset Pricing with Observable Stochastic Discount Factors," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 397-446, July.
    16. Munk, Claus, 2015. "Financial Asset Pricing Theory," OUP Catalogue, Oxford University Press, number 9780198716457.
    17. Lena Dräger & Michael J. Lamla, 2024. "Consumers' macroeconomic expectations," Journal of Economic Surveys, Wiley Blackwell, vol. 38(2), pages 427-451, April.
    18. Rui Albuquerque & Martin Eichenbaum & Victor Xi Luo & Sergio Rebelo, 2016. "Valuation Risk and Asset Pricing," Journal of Finance, American Finance Association, vol. 71(6), pages 2861-2904, December.
    19. LuisM. Viceira & John Y. Campbell, 2001. "Who Should Buy Long-Term Bonds?," American Economic Review, American Economic Association, vol. 91(1), pages 99-127, March.
    20. Thomas B. King, 2013. "A Portfolio-Balance Approach to the Nominal Term Structure," Working Paper Series WP-2013-18, Federal Reserve Bank of Chicago.
    21. Ang, Andrew & Bekaert, Geert & Liu, Jun, 2005. "Why stocks may disappoint," Journal of Financial Economics, Elsevier, vol. 76(3), pages 471-508, June.

    More about this item

    Keywords

    ;
    ;
    ;
    ;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:arqudp:323203. See general information about how to correct material in RePEc.

    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 CitEc recognized a bibliographic reference but did not link an item in RePEc 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ZBW - Leibniz Information Centre for Economics (email available below). General contact details of provider: http://www.arqus.info/ .

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

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.