← Search

Journal of Finance Vol. 60 No. 2 2005

Optimal Life‐Cycle Asset Allocation: Understanding the Empirical Evidence

Francisco Gomes1,2,3,4,5,6,7,8; Alexander Michaelides1,2,3,4,5,6,7,8

1 University of North Carolina at Chapel Hill · 2 Federal Reserve · 3 SIL International · 4 University of North Carolina Health Care · 5 Federal Reserve Board of Governors · 6 London Business School · 7 Carnegie Mellon University · 8 London School of Economics and Political Science

open access

Abstract

We show that a life-cycle model with realistically calibrated uninsurable labor income risk and moderate risk aversion can simultaneously match stock market participation rates and asset allocation decisions conditional on participation. The key ingredients of the model are Epstein–Zin preferences, a fixed stock market entry cost, and moderate heterogeneity in risk aversion. Households with low risk aversion smooth earnings shocks with a small buffer stock of assets, and consequently most of them (optimally) never invest in equities. Therefore, the marginal stockholders are (endogenously) more risk averse, and as a result they do not invest their portfolios fully in stocks.

DOI
10.1111/j.1540-6261.2005.00749.x
Volume
60
Issue
2
Pages
869-904
Language
en
Sources
bibtex:phds-export.bib openalex openalex crossref

Cite