scholarly journals Labor Income Dynamics at Business-Cycle Frequencies: Implications for Portfolio Choice

2006 ◽  
Author(s):  
Sinan Tan ◽  
Anthony W. Lynch
Keyword(s):  
Business Cycle ◽  
Portfolio Choice ◽  
Labor Income ◽  
Income Dynamics

MARKET FRICTIONS, SAVINGS BEHAVIOR, AND PORTFOLIO CHOICE

1997 ◽  
Vol 1 (1) ◽  
pp. 76-101 ◽  
Author(s):  
JOHN HEATON ◽  
DEBORAH LUCAS
Keyword(s):  
Portfolio Choice ◽  
Portfolio Allocation ◽  
Market Frictions ◽  
Labor Income ◽  
Theoretic Model ◽  
Income Risk ◽  
Habit Persistence ◽  
Savings Behavior ◽  
Short Sale Constraints ◽  
Short Sale

We examine a decision theoretic model of portfolio choice in which investors face income risk that is not directly insurable. We consider the sensitivity of savings and portfolio allocation rules to different assumptions about utility, the stochastic process for income and asset returns, and market frictions (transactions costs and short-sale constraints). Under CRRA time additive utility, habit persistence utility, and for a broad range of parameterizations, the model predicts that investors wish to borrow and invest all of their savings in stocks. This qualitative implication is robust to the introduction of significant transaction costs in the stock market, and contrasts sharply with portfolio allocation models in which there is no labor income.

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