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Optimal asset allocation in the presence of nonfinancial assets

Abstract

In this paper, a comprehensive mean-variance model, which includes all major nonfinancial assets (housing, human capital, and private business) besides financial ones is calibrated with empirical data to generate optimal asset allocations between stocks, bonds, and cash. The model is used to investigate the effect that each of the nonfinancial assets has on the optimal mix of financial assets. Among others, it generates the optimal portfolio allocation for investors working in different industries and living in different cities. The model is also able to rationalize a popular investment advice recommending decreasing share of stocks in financial portfolios with increasing age.

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