Portfolio Choice Over the Life-Cycle in the Presence of Cointegration Between Labor Income and Inflation
Author | : Yang Zhou |
Publisher | : |
Total Pages | : 48 |
Release | : 2015 |
ISBN-10 | : OCLC:1306920897 |
ISBN-13 | : |
Rating | : 4/5 (97 Downloads) |
Book excerpt: We study portfolio choice for a finite-horizon investor whose labor income is cointegrated with inflation. We show that this long-run relationship has substantial impact on the riskiness of human capital and consequently on the optimal portfolio strategy. Because cointegration raises the long-run correlation between human capital and inflation, young investors' human capital effectively hedges inflation risk and crowds out the allocation to inflation-indexed bonds. However, the hedging power of human capital diminishes for older investors because of a weaker cointegration effect and less importance of human capital in total wealth. These effects together show that inflation-indexed bonds matter more for older investors than for young investors.