True/False An investor with high initial financial wealth and human capital less risky than the stock market, should have a higher allocation to risky assets. True/false? An investor with a weak bequest motive will have a lower demand for life insurance. True/false? An investor with high financial wealth will have a higher dermand for life insurance. True/false? An investor with high correlation between his wage growth rate and stock returns will have a lower demand for life insurance. True / false?
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1st question has two contradictory points, high financial capital implies lower risk asset allocation, low risk hc implies higher risk fc. Would depend on relative size of fc and hc. If fc relatively large to hc, lower allocation to risk. If fc relatively small to hc, higher. From a relative standpoint the fc definetely has lower risk assets than someone who has minimal fc. With minimal fc, all money goes into fc to weight out hc. If large amounts of fc, asset allocation implies higher fixed.
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true true false true - My reasoning for this is that Human Capital is risky like Equity and requires high discount rate which reduces the Present Value of Human Capital hence less need for life insurance
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OK From the book. Assume that we hold the investor’s age at 45 and set risk preference at a moderate level. Figure 10 shows that optimal allocation to the risk-free asset increases with initial wealth. This situtaion may seem to be inconsistent because the CRRA function implies that the optimal asset allocation will not change with the amount of wealth that the inevestor has. Note, however that “wealth” here includes both financial wealth and human capital. In fact, this situation is a classic example of the impact of human capital on optimal allocation. An increase in intiial financial wealth not only increases total wealth but also reduces the percentage of total wealth represented by human capital. In this case, HUMAN CAPITAL IS LESS RISKY THAN THE RISKY ASSET (shocks to labor income is .2). When initial wealth low, human capital dominates total wealth and asset allocation. As a result, to achieve the target asset allocation of a moderate investor–say, an allocation of 60 percent to the risk-free asset and 40 percent to the risky asset–the closet allocation is to invest 100 percent of financial wealth in the risk asset because human capital is illiquid. As initial wealth rises, the asset allocation gradually approaches the target asset allocation that a moderately risk-averse investor desire. and here is the key. In summary, for a typical investor whose human capital is less risky than the stock market, the optimal allocation is more conservative the more financial assets the investor has. So in summary 1.) depends on 2 key factors, how high is initial wealth and what you define as “higher allocation to risky assets.” Higher should definitely not be relative to others who have low initial wealth and from an absolute standpoint to maintain 60/40 mix they could have a higher allocation to RFR depending on how high the initial wealth is. Where is this question from? And on a side note, this is exactly why this curriculum becomes so goofy, lots and lots of parts are very ambiguous. The good thing from all the tests they are very good at asking exactly what they want and comparing things that are “average” to other entities.