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Optimal life-cycle portfolios for heterogeneous workers

Author

Listed:
  • Fabio Bagliano
  • Carolina Fugazza
  • Giovanna Nicodano
Abstract
Household portfolios include risky bonds, beyond stocks, and respond to permanent labour income shocks. This paper brings these features into a life-cycle setting, and shows that optimal stock investment is constant or increasing in age before retirement for realistic parameter combinations. The driver of such inversion in the life-cycle profile is the resolution of uncertainty regarding social security pension, which increases the investor’s risk appetite. This occurs if a small positive contemporaneous correlation between permanent labour income shocks and stock returns is matched by a realistically high degree of risk aversion. Absent this combination, the typical downward sloping profile obtains. Overlooking differences in optimal investment profiles across heterogeneous workers results in large welfare losses, in the order of 15-30% of lifetime consumption.

Suggested Citation

  • Fabio Bagliano & Carolina Fugazza & Giovanna Nicodano, 2013. "Optimal life-cycle portfolios for heterogeneous workers," Working Papers 260, University of Milano-Bicocca, Department of Economics, revised Dec 2013.
    • Handle: RePEc:mib:wpaper:260
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    1. Boon, L.N. & Brière, M. & Rigot, S., 2018. "Regulation and pension fund risk-taking," Journal of International Money and Finance, Elsevier, vol. 84(C), pages 23-41.
    2. Tsai, Hui-Ju & Wu, Yangru, 2014. "Optimal portfolio choice for investors with industry-specific labor income risks," Finance Research Letters, Elsevier, vol. 11(4), pages 429-436.
    3. Mao, Mike Qinghao & Wong, Ching Hin, 2022. "Why have target-date funds performed better in the COVID-19 selloff than the 2008 selloff?," Journal of Banking & Finance, Elsevier, vol. 135(C).
    4. Fabio C. Bagliano & Raffaele Corvino & Carolina Fugazza & Giovanna Nicodano, 2018. "Hedging Labor Income Risk over the Life-Cycle," Working papers 058, Department of Economics, Social Studies, Applied Mathematics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino.
    5. Bagliano, Fabio C. & Fugazza, Carolina & Nicodano, Giovanna, 2019. "Life-cycle portfolios, unemployment and human capital loss," Journal of Macroeconomics, Elsevier, vol. 60(C), pages 325-340.
    6. Fabio C. Bagliano & Carolina Fugazza & Giovanna Nicodano, 2017. "A Life-Cycle Model with Unemployment Traps," Carlo Alberto Notebooks 514, Collegio Carlo Alberto, revised 2019.
      • Fabio C. Bagliano & Carolina Fugazza & Giovanna Nicodano, 2017. "A Life-Cycle Model with Unemployment Traps," Working papers 041, Department of Economics, Social Studies, Applied Mathematics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino.
    7. d'Astous, Philippe & Shore, Stephen H., 2024. "Human capital risk and portfolio choices: Evidence from university admission discontinuities," Journal of Financial Economics, Elsevier, vol. 154(C).
    8. Ashok Thomas & Luca Spataro, 2018. "Financial Literacy, Human Capital and Stock Market Participation in Europe," Journal of Family and Economic Issues, Springer, vol. 39(4), pages 532-550, December.
    9. Mao, Mike Qinghao & Wong, Ching Hin, 2022. "Managerial commitment and heterogeneity in target-date funds," Journal of Empirical Finance, Elsevier, vol. 68(C), pages 1-19.
    10. Munk, Claus, 2020. "A mean-variance benchmark for household portfolios over the life cycle," Journal of Banking & Finance, Elsevier, vol. 116(C).
    11. Bagliano, Fabio C. & Fugazza, Carolina & Nicodano, Giovanna, 2021. "Life-cycle welfare losses from rules-of-thumb asset allocation," Economics Letters, Elsevier, vol. 198(C).
    12. Ashtiani, Amin Zokaei & Rieger, Marc Oliver & Stutz, David, 2021. "Nudging against panic selling: Making use of the IKEA effect," Journal of Behavioral and Experimental Finance, Elsevier, vol. 30(C).
    13. Bagliano, Fabio C. & Fugazza, Carolina & Nicodano, Giovanna, 2024. "Life-cycle risk-taking with personal disaster risk," International Review of Economics & Finance, Elsevier, vol. 89(PB), pages 378-396.
    14. Kees de Van & Daniele Fano & Herialt Mens & Giovanna Nicodano, 2014. "A Reporting Standard for Defined Contribution Pension Plans," CeRP Working Papers 143, Center for Research on Pensions and Welfare Policies, Turin (Italy).
    15. Branger, Nicole & Larsen, Linda Sandris & Munk, Claus, 2019. "Hedging recessions," Journal of Economic Dynamics and Control, Elsevier, vol. 107(C), pages 1-1.

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    More about this item

    Keywords

    Life-cycle portfolio choice; background risk; age rule; investor heterogeneity; stock market participation;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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