| This dissertation examines how households should optimally allocate their portfolio choices between risky stocks and risk-free bonds over their lifetime. Traditional lifecycle models in previous work with normal-distributed stock returns suggest that the allocation toward stocks should start high (near 100%) early in life and decline over a person's age as human capital depreciates. These models also suggest that, with homothetic utility, the allocation should be roughly independent of a household's permanent income. The actual empirical evidence, however, indicates more of a "hump" shape allocation over the lifecycle; the lifetime poor also hold a smaller percentage of their portfolio in stocks relative to higher-income groups. Households, therefore, appear to be making considerable "mistakes" in their portfolio allocation. Target date funds, which have grown enormously during the past five years, aim to simplify the investment process in a manner consistent with the predictions of this traditional model.;This dissertation reconsiders the portfolio choice allocation in a computationally-demanding lifecycle model in which households face uninsurable wage shocks, uncertain lifetime, liquid account, g-and-h distributed stock returns, as well as a progressive and wage-indexed social security system. It demonstrates that the portfolio allocation "mistakes" being made by the vast majority of households actually lead to larger levels of welfare relative to the traditional advice incorporated in target date funds. |
