Financial Investment and Human Capital During Life Cycle

Abstract

This paper explores the problem of an agent who invests in financial assets, works and/or accumulates human capital, and retires at the end of time horizon. His/her initial endowments consist of an amount of liquid assets (maybe because of inheritance) and a number of units of human capital.Human capital is measured in efficiency units, as in the theory of growth. By contrast to the theory of growth, efficiency units increase as the result of training and education. Training is a costly activity; in addition to paying educational costs, the agent devotes part of his/her human capital exclusively to education and, thus, he/she can devote less time to earn labour income.The methodology similar to the Kreps-Proteus (KP) and Epstein-Zin (EZ) preferences. The certainty equivalent of life-time utility is evaluated by means of the negative exponential function. In addition, the wealth at the beginning of a period is an anchor point which determines the attitude to risk for that period. The attitude to risk and the utility of wealth evolve over time under the impact of past experiences and the anticipation of future events.Some of the main results are: (i) Optimal policies are linear functions of wealth: the marginal propensities to consume and to invest in financial assets are determined recursively and they are independent of the level of wealth of each period. (ii) The Certainty equivalent (CE) of the portfolio’s risk premium is the sum of the CE of the risk premia attached to financial assets and human capital, both expressed per unit of initial wealth of a period. (iii) The attitude to risk is characterized by an intrinsic attitude which is unchanged during the lifetime of the individual. This attitude is modified depending on whether the agent faces dynamic or timeless choices. In the case of dynamic choices, the intrinsic measure is modified by the realization of random events related to past choices. In timeless choices, the atemporal measure allows the agent to evaluate future anticipations under the experiences of the past. (iv) On economic considerations alone, the choice of educational plan at the beginning of the life cycle is either zero, or the maximum possible. It is independent of the measure of risk aversion and depends on other (not specified) personal preference and social conditions.