Finance and Economics Discussion Series (FEDS)
December 2024
Life-Cycle Portfolio Choices and Heterogeneous Stock Market Expectations
Mateo Velásquez-Giraldo
Abstract:
Survey measurements of households' expectations about U.S. equity returns show substantial heterogeneity and large departures from the historical distribution of actual returns. The average household perceives a lower probability of positive returns and a greater probability of extreme returns than history has exhibited. I build a life-cycle model of saving and portfolio choices that incorporates beliefs estimated to match these survey measurements of expectations. This modification enables the model to greatly reduce a tension in the literature in which models that have aimed to match risky portfolio investment choices by age have required much higher estimates of the coefficient of relative risk aversion than models that have aimed to match age profiles of wealth. The tension is reduced because beliefs that are more pessimistic than the historical experience reduce people's willingness to invest in stocks.
Keywords: Consumption and Saving, Heterogeneous Beliefs, Life cycle dynamics, Portfolio choice
DOI: https://doi.org/10.17016/FEDS.2024.097
PDF: Full Paper
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