Discussion Paper

Collateralized borrowing and life-cycle portfolio choice

Abstract: We examine the effects of collateralized borrowing in a realistically parameterized life-cycle portfolio choice problem. We provide basic intuition in a two-period model and then solve a multi-period model computationally. Our analysis provides insights into life-cycle portfolio choice relevant for researchers in macroeconomics and finance. In particular, we show that standard models with unlimited borrowing at the riskless rate dramatically overstate the gains to holding equity when compared with collateral-constrained models. Our results do not depend on the specification of the collateralized borrowing regime: The gains to trading equity remain relatively small even with the unrealistic assumption of unlimited leverage. We argue that our results strengthen the role of borrowing constraints in explaining the portfolio participation puzzle, that is, why most investors do not own stock.

Keywords: Margin accounts; Investments; Securities;

Bibliographic Information

Provider: Federal Reserve Bank of Boston

Part of Series: Public Policy Discussion Paper

Publication Date: 2006

Number: 06-4