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Optimal portfolios with wealth-varying risk aversion in the neoclassical growth model

Optimal portfolios with wealth-varying risk aversion in the neoclassical growth model Abstract This paper provides a rationale for fixed portfolios that exhibit fund separation as an optimal general equilibrium strategy when heterogeneous investors have wealth-varying relative risk aversion in the context of the standard stochastic neoclassical growth model. Agents’ wealth heterogeneity varies endogenously through time. Preferences exhibit linear risk tolerance with respect to consumption, consumption and labor are separable and the momentary utility function for leisure is isoelastic. Production possibilities are represented by J neoclassical technologies which are subject to shocks. I show that any competitive equilibrium allocation that is Pareto optimal can be supported by means of constant portfolios with only a few assets: a mutual fund of stocks, a consol and two other securities perfectly linearly correlated with aggregate labor income and the wage rate. Remarkably, this result holds in spite of the changing degree of agents’ heterogeneity and wealth-varying relative risk aversion, both stemming from movements in the stock of capital. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The B.E. Journal of Macroeconomics de Gruyter

Optimal portfolios with wealth-varying risk aversion in the neoclassical growth model

Espino, Emilio
The B.E. Journal of Macroeconomics , Volume 14 (1) – Jan 1, 2014
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Publisher
de Gruyter
Copyright
Copyright © 2014 by the
ISSN
2194-6116
eISSN
1935-1690
DOI
10.1515/bejm-2012-0044
Publisher site
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Abstract

Abstract This paper provides a rationale for fixed portfolios that exhibit fund separation as an optimal general equilibrium strategy when heterogeneous investors have wealth-varying relative risk aversion in the context of the standard stochastic neoclassical growth model. Agents’ wealth heterogeneity varies endogenously through time. Preferences exhibit linear risk tolerance with respect to consumption, consumption and labor are separable and the momentary utility function for leisure is isoelastic. Production possibilities are represented by J neoclassical technologies which are subject to shocks. I show that any competitive equilibrium allocation that is Pareto optimal can be supported by means of constant portfolios with only a few assets: a mutual fund of stocks, a consol and two other securities perfectly linearly correlated with aggregate labor income and the wage rate. Remarkably, this result holds in spite of the changing degree of agents’ heterogeneity and wealth-varying relative risk aversion, both stemming from movements in the stock of capital.

Journal

The B.E. Journal of Macroeconomics – de Gruyter

Published: Jan 1, 2014

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