The people at different stages of their life-cycle

The co-called baby-boom phenomenon in the US has inspireda lot of research on effects of this generation on the economy. In particular,90s and 2000s is the period when this generation will reach retirement.Therefore it is especially interesting to know what implications may be onwelfare, labor market and stock markets. Yoo (1994) shows that demographicfactors significantly influences the economy, in particularly savings,especially at low frequencies. Bakshi and Chen (1994) in their influential study arguethat if demography can influence certain macroeconomic parameters, then it isessential to understand how changes in age structure of a population can affectthe stock market. The authors attempted to address two hypotheses – life-cycleinvestment hypothesis and life-cycle risk-aversion hypothesis.

In thelife-cycle investment hypothesis Bakshi and Chen (1994) address the compositionof savings of an investor. Essentially they investigate the changing preferenceof investment into stock market or housing, which changes through aging of theeconomic agent. The authors argue, that in younger age people tend to have highhousing demands, thus in this age people tend to invest less into stock market.However by getting older, people solve their housing problems and start toinvest into the stock market to help finance their retirement. Moreover Bakshiand Chen (1994) propose that the older people get the more risk-averse theybecome.

Hence the increase in equity risk premiums can be correlated with anaging population, according to Bakshi and Chen (1994). As a proxy for agecomposition they use an average age of a population, S&P 500 index – stockmarket and residential investment deflator over GNP deflator – proxy forhousing market. Bakshi and Chen (1994) found strong support for their savingshypothesis, especially in the period post 1945. As for life-cycle riskaversion, they identified average age as a significant predictor of equitypremiums from 1990 – 1990, in contrast to dividend yield and consumptiongrowth. Bergantino (1998) used a slightly different approach.

He looked at agedistribution of a population and how people at different stages of theirlife-cycle interact with the financial markets. An obvious question is, what will happen to the financialmarkets, when the baby boomers generation will no longer be an active player inan economy. Brooks (2000), states that there are two views on this: either thebaby-boomers will sell of their assets to the new generation, which will eventuallydrive the prices down or the information of the future retirement of the babyboomers is already incorporated in the price and therefore no significanteffect will be noticed. Brooks (2000) concluded that despite the markets areforward looking and investors are rational, aging of a population has asignificant effect on the financial markets, which implies that governmentshave to develop policies to smooth out the effects of transitions ofgenerations

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