NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Portfolio Choice with Sustainable Spending: A Model of Reaching for Yield

John Y. Campbell, Roman Sigalov

NBER Working Paper No. 27025
Issued in April 2020
NBER Program(s):Asset Pricing, Monetary Economics

We show that reaching for yield—a tendency to take more risk when the real interest rate declines while the risk premium remains constant—results from imposing a sustainable spending constraint on an otherwise standard infinitely lived investor with power utility. This is true for two alternative versions of the constraint which make wealth and consumption follow martingales in levels or in logs, respectively. Reaching for yield intensifies when the interest rate is initially low, helping to explain the salience of the topic in the current low-rate environment. The sustainable spending constraint also affects the response of risktaking to a change in the risk premium, which can even be negative when the riskless interest rate is sufficiently low. In a variant of the model where the sustainable spending constraint is formulated in nominal terms, low inflation also encourages risktaking.

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Document Object Identifier (DOI): 10.3386/w27025

 
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