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Life-Cycle Portfolio Choice: The Role of Heterogeneity and Under-diversification

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  • Claudio Campanale

    (Universidad de Alicante)

Abstract

The empirical work on household portfolio choice documents two facts. One, the stock market participation rate is low and hump-shaped over the life-cycle, two, the conditional share of stocks is also low but does not appear to change much during the life-cycle. In contrast the standard life-cycle portfolio choice model predicts high and monotonically increasing participation rates and conditional stock shares that are low and exhibit dramatic changes with age. In this paper I consider a number of extensions to this basic framework. I find that a small per period participation cost is needed to generate a hump shaped life-cycle profile of participation rates. Under a realistic calibration the quantitative effect is minor. Progressive social security and the assumption that the risk of stock portfolios is declining in household wealth as a consequence of better diversification opportunities 'an assumption that has some empirical support' though provide substantial amplification and significantly improve the ability of the model to match the data. Under-diversification also reduces the average portfolio share of stocks conditional on participation and, together with the intergenerational transmission of wealth makes it insensitive to age, consistent with the empirical evidence.

Suggested Citation

  • Claudio Campanale, 2008. "Life-Cycle Portfolio Choice: The Role of Heterogeneity and Under-diversification," Working Papers. Serie AD 2008-06, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    • Handle: RePEc:ivi:wpasad:2008-06
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    References listed on IDEAS

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    Keywords

    Portfolio choice; life-cycle; bequests; diversification; social security.;
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