Working Paper: NBER ID: w12309
Authors: Paul Willen; Felix Kubler
Abstract: We examine the effects of collateralized borrowing in a realistically parameterized life-cycle portfolio choice problem. We provide basic intuition in a two-period model and then solve a multi-period model computationally. Our analysis provides insights into life-cycle portfolio choice relevant for researchers in macroeconomics and finance. In particular, we show that standard models with unlimited borrowing at the riskless rate dramatically overstate the gains to holding equity when compared with collateral-constrained models. Our results do not depend on the specification of the collateralized borrowing regime: the gains to trading equity remain relatively small even with the unrealistic assumption of unlimited leverage. We argue that our results strengthen the role of borrowing constraints in explaining the portfolio participation puzzle, that is, why most investors do not own stock.
Keywords: collateralized borrowing; lifecycle portfolio choice; equity demand; participation puzzle
JEL Codes: G11; D14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| borrowing constraints (F34) | equity demand (R21) |
| collateralized borrowing (G51) | gains from equity trading (G12) |
| collateralized borrowing (G51) | equity demand (R21) |
| borrowing constraints (F34) | participation puzzle (D72) |
| equity holdings as collateral (G32) | lifetime certain-equivalent consumption (D15) |