HEC Research Papers Series,
HEC Paris

Abstract: This paper presents a life-cycle model that incorporates the cyclical skewness of labor income shocks. Cyclical skewness can explain the limited stock market participation of households with modest financial wealth and the positive age trend in conditional equity shares. Structural estimation reveals that a relative risk aversion of 5 and a yearly participation cost of $290 fits the US data. Omitting cyclical skewness leads to a three-fold overestimation of participation costs and generates a counterfactual decline of conditional equity shares. As its portfolio implications are smaller for wealthy households, cyclical skewness reduces aggregate demand for equity by only 15%.

Keywords: Household finance; Labor income risk; Portfolio choices; Human capital; Life-cycle model; Simulated method of moments

JEL-codes: D14; D91; G11; G12; H60; J24

48 pages, May 13, 2016

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