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Federal Reserve Bank of Boston
Public Policy Discussion Paper
Collateralized borrowing and life-cycle portfolio choice
Paul S. Willen
Felix Kubler
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.


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Paul S. Willen & Felix Kubler, Collateralized borrowing and life-cycle portfolio choice, Federal Reserve Bank of Boston, Public Policy Discussion Paper 06-4, 2006.
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Keywords: Margin accounts ; Investments ; Securities
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