Life cycle investment behavior, demographics and asset prices

Thesis (Ph.D.)--Massachusetts Institute of Technology, Dept. of Economics, 1998.Includes bibliographical references (p. 127-131).This thesis investigates the relationship between demographics and asset prices. More specifically it examines the effect of changes in the age distribution of the U.S. population on housing, stock, and bond prices over the post World War II period in the U.S. This is done in two steps. First, survey data on household asset holdings is used to construct age profiles of household demand for housing, stocks, bonds, and debt. These asset demand profiles are combined with data on the age distribution of the U.S. population to construct time series measures of aggregate demographic demand for housing, financial assets net of debt, and stocks in excess of bonds, which are then used to analyze the effects of demographically driven changes in aggregate asset demand on equilibrium asset prices over the period from 1946 through 1997. The results of this exercise suggest several interesting findings. With respect to the microeconomic issue of life cycle investment behavior, one finds that the scale and composition of household asset demand changes dramatically over the course of the economic life cycle. Young households, that is, households with heads under age 40, tend to draw credit out of financial markets, primarily by issuing mortgage contracts for the purchase of houses. The extent of this and other borrowing done by young households tends to exceed any gross contributions they make to financial markets through transactions accounts, mutual funds, retirement plans, etc., making them net negative investors in financial assets on average. In contrast, households with heads between ages 40 and 60, tend to provide substantial amounts of credit to financial markets. Much of this saving is, at least nominally, retirement saving, held in personal retirement accounts and employer provided pensions. Households with heads over age 60 tend, like younger households, to drain credit from financial markets. However, unlike young households, older households draw credit out of financial markets not by borrowing, rather, by using previously accumulated assets to fund consumption during retirement. Due to large shifts in the age distribution of the U.S. population since 1946, these life cycle investment patterns appear to have had significant macroeconomic consequences. Tests of the correlation between the constructed demographic demand variables and corresponding asset price series, suggest a statistically significant link between demographic changes in the U.S. population and observed long run movements in housing, stock, and bond prices. This is true even after controlling for the effects of other factors such as fluctuations in real GDP (in the case of housing and bond prices) and dividends (in the case of stock prices). Estimated elasticities of real housing prices with respect to the demographic demand for housing suggest that demographic factors can account for approximately 59% of the observed annual increase in real housing prices between 1966 and 1986. Similarly, demographically driven changes in the demand for financial assets can account for approximately 77% of the observed annual increase in real stock prices between 1986 and 1997 and can account for at least 81 % of the observed annual increase in real bond prices. As for the future, current Census Bureau population projections suggest that annual growth in demographic housing demand will provide a positive stimulus of about 0.35% per year to real housing price appreciation between 1997 and 2007, down from about 0.98% per year for the period between 1986 to 1997, and 1.02% per year for the period between 1966 and 1986. Growth in the demographic demand for financial assets is expected to provide a positive stimulus to real stock and bond price appreciation of about 8.76% per year between 1997 and 2007, up from about 6.62% per year for the period between 1986 and 1997, and -1.34% per year for the period between 1966 and 1986.by Steven M. Bergantino.Ph.D