We examine a decision theoretic model of portfolio
choice in which investors face income risk that is not directly
insurable. We consider the sensitivity of savings and portfolio
allocation rules to different assumptions about utility, the
stochastic process for income and asset returns, and market frictions
(transactions costs and short-sale constraints). Under CRRA time
additive utility, habit persistence utility, and for a broad range of
parameterizations, the model predicts that investors wish to borrow
and invest all of their savings in stocks. This qualitative
implication is robust to the introduction of significant transaction
costs in the stock market, and contrasts sharply with portfolio
allocation models in which there is no labor income.
