Gomes, Francisco J. and Michaelides, Alexander (2003) Portfolio choice with internal habit formation : a life-cycle model with uninsurable labor income risk. Review of Economic Dynamics, 6 (4). pp. 729-766. ISSN 1094-2025
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Abstract
Motivated by the success of internal habit formation preferences in explaining asset pricing puzzles, we introduce these preferences in a life-cycle model of consumption and portfolio choice with liquidity constraints, undiversifiable labor income risk and stock-market participation costs. In contrast to the initial motivation, we find that the model is not able to simultaneously match two very important stylized facts: a low stock market participation rate, and moderate equity holdings for those households that do invest in stocks. Habit formation increases wealth accumulation because the intertemporal consumption smoothing motive is stronger. As a result, households start participating in the stock market very early in life, and invest their portfolios almost fully in stocks. Therefore, we conclude that, with respect to its ability to match the empirical evidence on asset allocation behavior, the internal habit formation model is dominated by its time-separable utility counterpart.
| Item Type: | Article |
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| Official URL: | http://www.economicdynamics.org/review.htm |
| Additional Information: | Copyright © 2003 Elsevier Inc. LSE has developed LSE Research Online so that users may access research output of the School. Copyright © and Moral Rights for the papers on this site are retained by the individual authors and/or other copyright owners. Users may download and/or print one copy of any article(s) in LSE Research Online to facilitate their private study or for non-commercial research. You may not engage in further distribution of the material or use it for any profit-making activities or any commercial gain. You may freely distribute the URL (http://eprints.lse.ac.uk) of the LSE Research Online website. A persistent link to the article is available at http://dx.doi.org/10.1016/S1094-2025(03)00059-0 |
| Divisions: | Financial Markets Group Economics |
| Subjects: | H Social Sciences > HG Finance H Social Sciences > HB Economic Theory |
| JEL classification: | G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E21 - Macroeconomics: Consumption; Saving; Aggregate Physical and Financial Consumer Wealth |
| Date Deposited: | 29 Jun 2006 |
| Last Modified: | 23 Jan 2024 05:30 |
| URI: | http://eprints.lse.ac.uk/id/eprint/196 |
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