Working Paper: NBER ID: w9331
Authors: Steven J. Davis; Felix Kubler; Paul Willen
Abstract: We analyze consumption and portfolio behavior in a life-cycle model with realistic borrowing costs and income processes. We show that even a small wedge between borrowing costs and the risk-free return dramatically shrinks the demand for equity. When the cost of borrowing equals or exceeds the expected return on equity the relevant case according to the data households hold little or no equity during much of the life cycle. The model also implies that the correlation between consumption growth and equity returns is low at all ages, and that risk aversion estimates based on the standard excess return formulation of the consumption Euler Equation are greatly upward biased. The demand for equity in the model is non-monotonic in borrowing costs and risk aversion, and the standard deviation of marginal utility growth is an order of magnitude smaller than the Sharpe ratio.
Keywords: No keywords provided
JEL Codes: D91; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| borrowing costs (H74) | equity demand (R21) |
| borrowing costs (H74) | consumption growth (E20) |
| equity demand (R21) | consumption growth (E20) |
| age (J14) | correlation between consumption growth and equity returns (F62) |
| borrowing costs (H74) | risk aversion estimates (D81) |