We study the importance of time-varying bond risk premia in a consumption and portfolio-choice problem for a life-cycle investor facing short-sales and borrowing constraints. Tilts in the optimal asset allocation in response to changes in bond risk premia exhibit pronounced life-cycle patterns. We find that the investor is willing to pay an annual fee up to 1% to implement a strategy that optimally conditions on prevailing bond risk premia in addition to her age and wealth. To solve our model, we extend recently developed simulation-based techniques to life-cycle problems featuring multiple state variables and multiple risky assets.
Koijen, R. S. J., Nijman, T. E., & Werker, B. J. M. (2010). When can life-cycle investors benefit from time-varying bond risk premia? The Review of Financial Studies, 23(2), 741-780. https://doi.org/10.1093/rfs/hhp058