Resuscitating Businessman Risk: A Rationale For Familiarity-Based Portfolios

Abstract

In this paper I study household portfolio decisions over the life-cycle. I extend the theoretical literature on optimal intertemporal asset allocation positing that the …nitelived individual of this economy is enabled to change occupation during her working years. Her job-switching option replicates the payo¤ structure of an American spread option. I …nd that the individual optimally bears more own-occupation risk in her …nancial portfolio than if she did not have the extra "diversi…cation on-the-job" embedded in her option to change career. This e¤ect contributes to explain (i) the investors'tendency to choose "familiar" stocks, and (ii) the young businessmen pouring of money into risky investments versus the conservative strategies of old widows. Another remarkable result characterizing the individual's optimal investment behavior is the large absolute value of portfolio rebalancing over time. The qualitative implications of the model are robust to the variations in parameter values: increasing the individual's aversion to risk, the degree of uncertainty of her wage and the volatility level of her own-occupation stock does not generally invert observed trends. The model matches own-occupation stock holdings documented by the empirical evidence very closely and, because its speci…cation lends itself to various quali…cations of "occupations," if properly calibrated, it can predict optimal policies for a great variety of labor and …nancial market conditions.

Financial literacy and financial sophistication in the older population

“…For a discussion of the pros and cons of employer stock, see Benartzi et al . (2004) and Ruffino (2011).…”

Financial Sophistication in the Older Population

“…This is because the typical US worker will have a large part of his total wealth in human capital, so that labor earnings will be highly correlated with his employer's financial stability. For a discussion of the pros and cons of employer stock, seeBenartzi, Thaler, Utkus, and Sunstein (2004) andRuffino (2011).…”