Location of Repository

Portfolio choice, liquidity constraints and stock market mean reversion

By Alexander Michaelides

Abstract

This Paper solves numerically for the optimal consumption and portfolio choice of an infinitely lived investor facing short sales and borrowing constraints, undiversifiable labour income risk and a predictable time varying equity premium. The investor aggressively times the market while positive correlation between permanent earnings shocks and stock return innovations generates a substantial hedging demand for the riskless asset. Moreover, a speculative increase in savings arises when stock returns are expected to be high and conversely when future returns are expected to be low. Small information/optimization costs can make it optimal for an investor to assume i.i.d excess stock returns, both because liquidity constraints can be frequently binding and because households can smooth idiosyncratic earnings shock using a small buffer stock of wealth

Topics: HG Finance
Publisher: Centre for Economic Policy Research
Year: 2001
OAI identifier: oai:eprints.lse.ac.uk:5366
Provided by: LSE Research Online
Download PDF:
Sorry, we are unable to provide the full text but you may find it at the following location(s):
  • http://www.cepr.org (external link)
  • http://eprints.lse.ac.uk/5366/ (external link)
  • Suggested articles


    To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.