Benzoni, Luca Dufresne, Pierre Collin Goldstein, Robert S.
Year of Publication:
Working Paper, Federal Reserve Bank of Chicago 2007-11
We study portfolio choice when labor income and dividends are cointegrated. Economically plausible calibrations suggest young investors should take substantial short positions in the stock market. Because of cointegration the young agent's human capital effectively becomes stock-like. However, for older agents with shorter times-to-retirement, cointegration does not have sufficient time to act, and thus their human capital becomes more bond-like. Together, these effects create hump-shaped life-cycle portfolio holdings, consistent with empirical observation. These results hold even when asset return predictability is accounted for.