Consumption and Portfolio Choice over the Life Cycle

João F. Cocco; Francisco Gomes; Pascal J. Maenhout

doi:10.1093/rfs/hhi017

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Consumption and Portfolio Choice over the Life Cycle

João F. Cocco¹; Francisco Gomes¹; Pascal J. Maenhout²

¹ London Business School · ² INSEAD

Review of Financial Studies 2005

This article solves a realistically calibrated life cycle model of consumption and portfolio choice with non-tradable labor income and borrowing constraints. Since labor income substitutes for riskless asset holdings, the optimal share invested in equities is roughly decreasing over life. We compute a measure of the importance of human capital for investment behavior. We find that ignoring labor income generates large utility costs, while the cost of ignoring only its risk is an order of magnitude smaller, except when we allow for a disastrous labor income shock. Moreover, we study the implications of introducing endogenous borrowing constraints in this incomplete-markets setting.

DOI: 10.1093/rfs/hhi017
Volume: 18 (2)
Pages: 491-533
Language: en
Export: BibTeX
Sources: crossref openalex