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Labor-Market Uncertainty and Portfolio Choice Puzzles



The standard life-cycle model of household portfolio choice has difficulty generating a realistic age profile of risky share. Not only does the model imply a high risky share on average but also a steeply decreasing age profile, whereas the risky share increases with age in the data. In this paper, we show that age-dependent labor-market uncertainty is important in accounting for the observed age profile of risky share. A large uncertainty in the labor market---due to high unemployment risk, frequent job turnovers, and an unknown career path---prevents young workers from taking too much risk in the financial market. As the labor-market uncertainty is gradually resolved over time, workers can take more risk in their financial portfolios.

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