Life-cycle portfolios, unemployment and human capital loss

The recent Great Recession highlighted that long-term unemployment spells may entail persistent losses in workers’ human capital. This paper extends the life-cycle model of savings and portfolio choice with unemployment risk, by allowing the pos-sibility of permanent reductions in expected earnings following long-term unemploy-ment. The optimal risky portfolio share becomes flat in age due to the resolution of uncertainty about future returns to human capital that occurs as the worker ages. This may help explaining the observed relatively flat, or only moderately increasing, risky share of investors during working life, and have important consequences for the design of optimal life-cycle portfolios by investment funds.