CIRJE-F-565. Kobayashi, Takao, Risa Sai and Kazuya Shibata, "Human Capital as an Asset
Mix and Optimal Life-Cycle Portfolio: An Analytical Solution", June
2008.
This
study examines life-cycle optimal consumption and asset allocation in the
presence of human capital. Labor income seems like a "money market mutual
fund" whose balance in one or two years is predictable but a wide dispersion
results after many years, reflecting fluctuations in economic conditions. We
use the Martingale method to derive an analytical solution, finding that Merton’s
well-known "constant-mix strategy" is still true after incorporating
human capital from the perspective of "total wealth" management.
Moreover, the proportion in risky assets implicit in the agent’s human capital is
the main factor determining the optimal investment strategy. The numerical
examples suggest that young investors should short stocks because their human
capital has large market exposure. As they age, however, their human capital
becomes "bond-like", and thus they have to hold stocks to achieve
optimal overall risk exposure.