Essays on portfolio choice and asset pricing

The first part of this thesis analyzes the effects of robustness (a concern for model uncertainty) on dynamic portfolio and consumption decisions, and on equilibrium asset prices. In particular, I use the framework of Anderson, Hansen and Sargent (1999). Worried that the model she uses is misspecified, a robust agent seeks decision rules that insure against some worst-case misspecification, in accordance with maxmin expected utility. Robustness decreases the portfolio demand for equities. When modifying the framework of Anderson, Hansen and Sargent to impose homotheticity, I find robustness to be isomorphic to recursive preferences: robustness increases risk aversion without affecting the willingness to substitute intertemporally. When investment opportunities are stochastic, robustness leads to an additional hedging-type asset demand, even for logarithmic utility. In an equilibrium exchange economy, robustness increases the equilibrium equity premium and reduces the equilibrium riskfree rate.; The second part studies life-cycle portfolio choice and Social Security reform. Chapter 3 solves a realistically calibrated life-cycle model of consumption and portfolio choice with labor income uncertainty and borrowing constraints. Labor income substitutes for riskless asset holdings. The optimal share invested in equities is roughly decreasing over life. We evaluate the welfare loss of alternative investment strategies: ignoring labor income (Merton (1969)) generates large utility costs, while the cost of ignoring only labor income risk (Merton (1971)) is an order of magnitude smaller. Chapter 4 uses the life-cycle model of Chapter 3 to study Social Security reform. In a benchmark case, we find ex-ante welfare gains equivalent to a 3.7% increase in consumption from the investment of half of retirement wealth in the equity market. The main channel through which these gains are realized is that the higher average return on equities permits a lower Social Security tax rate, which helps households smooth their consumption over the life cycle. There is a smaller welfare gain of 0.5% of consumption when Social Security tax rates are held constant. We also find that realistic heterogeneity of risk aversion and labor income risk can strongly affect optimal portfolio choice over the life cycle and the welfare gains of social security reform.