Predictors and portfolios over the life cycle

  • Holger Kraft Holger Kraft
  • Claus Munk Claus Munk
  • Farina Weiss Farina Weiss

In a calibrated consumption-portfolio model with stock, housing, and labor income predictability, we evaluate the welfare effects of predictability on life-cycle consumption-portfolio choice. We compare skilled investors who are able to take advantage of all sources of predictability with unskilled investors ignoring predictability. For an unskilled investor the certainty equivalent of wealth is 0.3-6.8% lower than for a skilled investor, depending on the market entry date. We also determine the effect of luck to enter the market at a favorable time. Across market entry dates, skilled but unlucky investors can lose up to 15.4% compared to unskilled but lucky investors. Simulation studies confirm the relative importance of luck and document that, if anything, housing predictability is more important than stock predictability.

Keywords: Return predictability, scenarios, welfare, performance, housing

JEL Classification: G11, D91, D14

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