Claudio Giovanni Campanale (UniTo)

Preference for safety, heterogeneous beliefs and life-cycle portfolio allocation

Abstract: In the present paper I extend the standard model of life-cycle portfolio choice to allow for heterogeneous expectations about the equity return and a direct utility term for the holdings of the safe/liquid asset. Using recent empirical evidence I check the predictions of the model concerning the response of conditional stock shares to different degrees of optimism about the equity return, showing that the traditional model implies a response that is an order of magnitude above the empirical one while the model with preference for safety cuts the gap with the data by about 80 percent. I also show that heterogeneous beliefs and the preference for safety jointly provide a rich representation of stock market participation able to match the main patterns in the data with only minor monetary participation costs, while at the same time delivering a model that performs no worse than other alternative models that have been put forth for explaining the patterns of conditional stock shares.