Hostname: page-component-84b7d79bbc-rnpqb Total loading time: 0 Render date: 2024-07-28T15:11:24.589Z Has data issue: false hasContentIssue false
  • English
  • Français

Endogenous Labor/Leisure/Investment Choice under Time Constraints

Published online by Cambridge University Press:  08 April 2011

Dong-Hyun Ahn  and
Sun-Joong Yoon
Dong-Hyun Ahn
Affiliation:
School of Economics, Seoul National University, Gwanangno 599, Gwanak-gu, Seoul, Korea, ahnd@snu.ac.kr
Sun-Joong Yoon
Affiliation:
College of Business, Hallym University, Hallymdaehak-gil 1, Chuncheon, Kangwon-Do 200-702, Korea, sunjoong.yoon@hallym.ac.kr
Get access Rights & Permissions [Opens in a new window]

Abstract

We posit the opportunity cost of time required to manage risky investments, including conducting research and performance monitoring, as a potential explanation for the equity premium puzzle. An economic agent, who should allocate a limited amount of time to labor, leisure, and risky investment, is subject to the opportunity time cost of investment activity, which is foregone labor or leisure. Our model envisages its impact on equity premium and volatility in the presence of such a time constraint, in particular, with closed-form solutions to the risky asset returns, volatility, and risk-free rate in a simple equilibrium framework wherein agents have log utility. The model is shown to yield excess return and volatility consistent with historical values observed in the U.S. stock market, even with a small amount of time cost. In addition, the model enables us to sort out the impact of endogenous labor/leisure choice on return dynamics by comparing it with the exogenous labor income case.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 4 , August 2011 , pp. 1157 - 1192
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Abel, A. B.; Eberly, J. C.; and Panageas, S.. “Optimal Inattention to the Stock Market.” American Economic Review, 97 (2007), 244–249.CrossRefGoogle Scholar
Abramowitz, M., and Stegun, I. A.. Handbook of Mathematical Functions with Formulas, Graphs, and Mathematical Tables. New York, NY: Dover Publications, Inc. (1970).Google Scholar
Barberis, N.; Huang, M.; and Santos, T.. “Prospect Theory and Asset Prices.” Quarterly Journal of Economics, 116 (2001), 1–54.CrossRefGoogle Scholar
Becker, G. S. “A Theory of the Allocation of Time.” Economic Journal, 75 (1965), 493–517.CrossRefGoogle Scholar
Bodie, Z.; Merton, R. C.; and Samuelson, W. F.. “Labor Supply Flexibility and Portfolio Choice in a Life Cycle Model.” Journal of Economic Dynamics and Control, 16 (1992), 427–449.CrossRefGoogle Scholar
Breeden, D. T. “An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities.” Journal of Financial Economics, 7 (1979), 265–296.CrossRefGoogle Scholar
Campbell, J. Y. “Asset Prices, Consumption, and the Business Cycle.” In Handbook in Economics, Taylor, J. B. and Woodford, M., eds. Amsterdam, Netherlands: North-Holland (1999), 1231–1303.Google Scholar
Campbell, J. Y., and Cochrane, J. H.. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy, 107 (1999), 205–251.CrossRefGoogle Scholar
Campbell, J. Y., and Shiller, R. J.. “Stock Prices, Earnings, and Expected Dividends.” Journal of Finance, 43 (1988), 661–676.CrossRefGoogle Scholar
Carroll, C. D. “Buffer-Stock Saving and the Life-Cycle/Permanent Income Hypothesis.” Quarterly Journal of Economics, 112 (1997), 1–55.CrossRefGoogle Scholar
Cocco, J. F. “Portfolio Choice in the Presence of Housing.” Review of Financial Studies, 18 (2005), 535–567.CrossRefGoogle Scholar
Cocco, J. F.; Gomes, F. J.; and Maenhout, P. J.. “Consumption and Portfolio Choice over the Life-Cycle.” Review of Financial Studies, 18 (2005), 491–533.CrossRefGoogle Scholar
Cochrane, J. H.; Longstaff, F. A.; and Santa-Clara, P.. “Two Trees.” Review of Financial Studies, 21 (2008), 347–385.CrossRefGoogle Scholar
Constantinides, G. M. “Capital Market Equilibrium with Transaction Costs.” Journal of Political Economy, 94 (1986), 842–862.CrossRefGoogle Scholar
Davis, M. H. A., and Norman, A. R.. “Portfolio Selection with Transaction Costs.” Mathematics of Operations Research, 15 (1990), 676–713.CrossRefGoogle Scholar
Davis, S. J., and Willen, P.. “Income Shocks, Asset Returns, and Portfolio Choice.” In Innovations for Financing Retirement, Bodie, Z., Mitchell, O. S., Hammond, P. B., and Zeldes, S., eds. Philadelphia, PA: University of Pennsylvania Press (2002).Google Scholar
Duffie, D., and Sun, T.-S.. “Transactions Costs and Portfolio Choice in a Discrete-Continuous-Time Setting.” Journal of Economic Dynamics and Control, 14 (1990), 35–51.CrossRefGoogle Scholar
Eichenbaum, M. S.; Hansen, L. P.; and Singleton, K. J.. “A Time Series Analysis of Representative Agent Models of Consumption and Leisure Choice under Uncertainty.” Quarterly Journal of Economics, 103 (1988), 51–78.CrossRefGoogle Scholar
Gabaix, X., and Laibson, D.. “The 6D Bias and the Equity Premium Puzzle.” NBER Macroeconomics Annual 2001 (2002), 257–312.Google Scholar
Gomes, F., and Michaelides, A.. “Asset Pricing with Limited Risk Sharing and Heterogeneous Agents.” Review of Financial Studies, 21 (2008), 415–448.CrossRefGoogle Scholar
Gradshteyn, I. S., and Ryzhik, I. M.. Table of Integrals, Series, and Products, 6th ed.New York, NY: Academic Press (2000).Google Scholar
Gronau, R. “Leisure, Home Production, and Work: The Theory of the Allocation of Time Revisited.” Journal of Political Economy, 85 (1977), 1099–1124.CrossRefGoogle Scholar
Hansen, L. P., and Jagannathan, R.. “Implications of Security Market Data for Models of Dynamic Economies.” Journal of Political Economy, 99 (1991), 225–262.CrossRefGoogle Scholar
Hansen, L. P., and Singleton, K. J.. “Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models.” Econometrica, 50 (1982), 1269–1286.CrossRefGoogle Scholar
Heaton, J., and Lucas, D.. “Market Frictions, Savings Behavior, and Portfolio Choice.” Macroeconomic Dynamics, 1 (1997), 76–101.CrossRefGoogle Scholar
Heckman, J. “Shadow Prices, Market Wages, and Labor Supply.” Econometrica, 42 (1974), 679–694.CrossRefGoogle Scholar
Lettau, M., and Ludvigson, S.. “Consumption, Aggregate Wealth, and Expected Returns.” Journal of Finance, 55 (2001a), 815–849.CrossRefGoogle Scholar
Lettau, M., and Ludvigson, S.. “Resurrecting the (C)CAPM: A Cross-Sectional Test When Risk Premia Are Time-Varying.” Journal of Political Economy, 109 (2001b), 1238–1287.CrossRefGoogle Scholar
Lettau, M., and Ludvigson, S. C.. “Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption.” American Economic Review, 94 (2004), 276–299.CrossRefGoogle Scholar
Longstaff, F. A., and Piazzesi, M.. “Corporate Earnings and the Equity Premium.” Journal of Financial Economics, 74 (2004), 401–421.CrossRefGoogle Scholar
Lucas, R. E. Jr. “Asset Prices in the Exchange Economy.” Econometrica, 46 (1978), 1429–1446.CrossRefGoogle Scholar
Mayers, D. “Nonmarketable Assets and Capital Market Equilibrium under Uncertainty.” In Studies in the Theory of Capital Markets, Jensen, M., ed. New York, NY: Praeger (1972), 223–248.Google Scholar
Mehra, R., and Prescott, E. C.. “The Equity Premium: A Puzzle.” Journal of Monetary Economics, 15 (1985), 145–161.CrossRefGoogle Scholar
Menzly, L.; Santos, T.; and Veronesi, P.. “Understanding Predictability.” Journal of Political Economy, 112 (2004), 1–47.CrossRefGoogle Scholar
Merton, R. C. “Optimum Consumption and Portfolio Rules in a Continuous-Time Model.” Journal of Economic Theory, 3 (1971), 373–413.CrossRefGoogle Scholar
Prescott, E. C. “Theory Ahead of Business-Cycle Measurement.” Carnegie-Rochester Conference Series on Public Policy, 25 (1986), 11–44.CrossRefGoogle Scholar
Santos, T., and Veronesi, P.. “Labor Income and Predictable Stock Returns.” Review of Financial Studies, 19 (2006), 1–44.CrossRefGoogle Scholar
Shiller, R. J. “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends? “ American Economic Review, 71 (1981), 421–436.Google Scholar
Shiller, R. J. “Market Volatility and Investor Behavior.” American Economic Review, 80 (1990), 58–62.Google Scholar
U.S. Census Bureau. “Net Worth and Asset Ownership of Households: 1998 and 2000.” Survey of Income and Program Participation (SIPP), Household Economic Studies (2003).Google Scholar
U.S. Department of Labor, U.S. Bureau of Labor Statistics. “American Time Use Survey-2008 Results.” American Time Use Survey (ATUS) (2009).Google Scholar
Viceira, L. M. “Optimal Portfolio Choice for Long-Horizon Investors with Nontradable Labor Income.” Journal of Finance, 56 (2001), 433–470.CrossRefGoogle Scholar
Weil, P. “The Equity Premium Puzzle and the Risk-Free Rate Puzzle.” Journal of Monetary Economics, 24 (1989), 401–421.CrossRefGoogle Scholar
Yao, R., and Zhang, H. H.. “Optimal Consumption and Portfolio Choices with Risky Housing and Borrowing Constraints.” Review of Financial Studies, 18 (2005), 197–239.CrossRefGoogle Scholar