Stock-Bond Allocation over the Life Cycle with Long-Term Unemployment Risk.

The risk of income and employment shocks affect investors' saving and investment decisions and thus, in part, determines their well-being during their working years and in retirement. To study how this risk affects investors' decisions, we develop a life cycle consumption-investment model with explicitly modeled unemployment, job search, and retirement. The risk of potential long-term unemployment around the most productive years leads agents to increase savings and lower their portfolio risk at a young age. Contrary to previous findings that suggest a very high portfolio allocation to risky assets prior to retirement, we find that portfolio share in risky equities exhibits a hump shape prior to the most productive years in the labor market. Our analysis of unemployment insurance reveals that with higher unemployment benefits, investors save less and invest more in risky assets. [ABSTRACT FROM AUTHOR]