A reconciliation of two alternative approaches towards buffer stock saving.

This paper shows that the two main models in the buffer stock saving literature can be nested in a model that varies the level of available social insurance. Equivalently, the assumption about the time series process for labor income (and social insurance during unemployment) is crucial in determining the level (but not the shape) of optimal consumption as a function of liquid wealth.

Estimating the rational expectations model of speculative storage : a Monte Carlo comparison of three simulation estimators.

The non-negativity constraint on inventories imposed on the rational expectations theory of speculative storage implies that the conditional mean and variance of commodity prices are non-linear in lagged prices and have a kink at a threshold point. In this paper, the structural parameters of this model are estimated using three simulation-based estimators. In a Monte Carlo experiment, the finite sample properties of the simulated methods of moments estimator of Duffie and Singleton (1993, Econometrica 61 (4), 929–952) the indirect inference estimator of Gourieroux et al. (1993, Journal of Applied Economterics 8, S85–S118) and the efficient method of moments estimator of Gallant and Tauchen (1996, Econometric Theory 12, 657–681) are assessed. Exploiting the invariant distribution implied by the theory allows us to evaluate the error induced by simulations. Our results show that the estimators differ in their sensitivity to the sample size, the number of simulations, choice of auxiliary models, and computation demands. For some estimators, the test for overidentifying restrictions exhibit significant size distortions in small samples. Overall, while the simulation estimators have small bias, they are less efficient than pseudo-maximum likelihood (PMLE). Hence for the small sample sizes considered, the simulation estimators are still inferior to the PMLE estimates in a mean-squared sense.

Portfolio choice with internal habit formation : a life-cycle model with uninsurable labor income risk.

Motivated by the success of internal habit formation preferences in explaining asset pricing puzzles, we introduce these preferences in a life-cycle model of consumption and portfolio choice with liquidity constraints, undiversifiable labor income risk and stock-market participation costs. In contrast to the initial motivation, we find that the model is not able to simultaneously match two very important stylized facts: a low stock market participation rate, and moderate equity holdings for those households that do invest in stocks. Habit formation increases wealth accumulation because the intertemporal consumption smoothing motive is stronger. As a result, households start participating in the stock market very early in life, and invest their portfolios almost fully in stocks. Therefore, we conclude that, with respect to its ability to match the empirical evidence on asset allocation behavior, the internal habit formation model is dominated by its time-separable utility counterpart.

Optimal life cycle asset allocation : understanding the empirical evidence.

We show that a life-cycle model with realistically calibrated uninsurable labor income risk and moderate risk aversion can simultaneously match stock market participation rates and asset allocation decisions conditional on participation. The key ingredients of the model are Epstein–Zin preferences, a fixed stock market entry cost, and moderate heterogeneity in risk aversion. Households with low risk aversion smooth earnings shocks with a small buffer stock of assets, and consequently most of them (optimally) never invest in equities. Therefore, the marginal stockholders are (endogenously) more risk averse, and as a result they do not invest their portfolios fully in stocks.

How Deep is the Annuity Market Participation Puzzle?

Using UK microeconomic data, we analyze the empirical determinants of voluntary annuity market demand. We find that annuity market participation increases with financial wealth, life expectancy and education and decreases with other pension income and a possible bequest motive for surviving spouses. We then show that these empirically-motivated determinants of annuity market participation have the same, quantitatively important, effects in a life-cycle model of annuity and life insurance demand, saving and portfolio choice. Moreover, reasonable preference parameters predict annuity demand levels comparable to the data. For stockholders, a relatively strong bequest motive is sufficient to simultaneously generate balanced portfolios and low annuity demand.Annuities, portfolio choice, life insurance, bequest motive

Winners and Losers in Housing Markets

This paper is a quantitatively-oriented theoretical study into the interaction between housing prices, aggregate production, and household behaviour over a lifetime. We develop a life-cycle model of a production economy in which land and capital are used to build residential and commercial structures. We find that, in an economy where the share of land in the value of structures is large, housing prices react more to an exogenous change in expected productivity or the world interest rate, causing large redistribution effects between net buyers and net sellers of houses. Changing the financing constraint, however, has limited effects on housing prices.Real estates, Land, Housing Prices, Life cycle, Collateral constraints.

Winners and Losers in House Markets

This paper is a quantitatively-oriented theoretical study of the interaction between housing prices, aggregate production, and household behavior over a lifetime. We develop a life-cycle model of a production economy in which land and capital are used to build residential and commercial real estates. We find that, in an economy where the share of land in the value of real estates is large, housing prices react more to an exogenous change in expected productivity or the world interest rate, causing a large redistribution between net buyers and net sellers of houses. Changing financing constraints, however, has limited effects on housing prices.Real estates, land, housing prices, life cycle, collateral constraints

Quantifying the Distortionary Fiscal Cost of ‘The Bailout’

We utilize an overlapping generations model with endogenous production and incomplete markets to quantify the distortionary costs associated with financing the increase in government expenditures directed to investments in the private sector in 2008 and 2009 (also known as ‘the bailout’), and its differential impact on different groups of the population (in the USA). In our baseline calibration, this distortion corresponds to a loss of approximately $300 billion dollars in total household consumption. For plausible alternative assumptions regarding both the expected and actual duration of this increase in expenditures, or the willingness of foreign institutions and/or investors in absorbing additional government debt, this number can increase to$800 billion. We find that the cost falls more dramatically on those households which are either older and/or wealthier. Retirees face approximately 50% of the cost, as younger agents still expect to be alive when the economy has returned to its steady-state. Across wealth groups, the top 25% of the wealth distribution bears almost two thirds of the cost.Fiscal Policy, tax distortions, bailout, incomplete markets

International portfolio choice, liquidity constraints and the home equity bias puzzle.

This paper solves for optimal international portfolio choice in the presence of liquidity constraints and undiversifiable labor income risk. Optimal portfolios are internationally diversified while positive correlation between domestic stock market returns and permanent labor income shocks can generate a complete portfolio specialization in foreign stocks. Nevertheless, either small costs associated with investing abroad or a slightly positive domestic to foreign equity premium differential are sufficient to either deter households from participating in a foreign market or generate a substantial bias for home equities. The benefits of international diversification are limited because consumption fluctuations can be smoothed with a small amount of buffer stock saving, while exchange rate risk makes foreign investments less appealing to risk averse investors.

Evidence on the Insurance Effect of Redistributive Taxation

If households face uninsurable idiosyncratic earnings risk, theory predicts that redistributive tax and transfer systems have both an insurance and a distortionary effect. Exploiting the substantial variation of tax and transfer systems across US states we investigate the necessary traces of these two effects in the data: that state-level measures of redistributive taxation should correlate negatively with, (a) the standard deviation, and (b) the mean, of the within-state consumption distribution. We find that the first correlation is robust, supporting strongly the presence of an insurance effect. The distortionary effect can also be detected in the data but it is less precisely estimated.Undiversi¯able Earnings Risk, Consumption Insurance, Tax Distortions