Inflation, Money Demand and Portfolio Choice

We estimate a nominal life-cycle portfolio choice model using shopping coststo generate money demand. The model delivers realistic implications forstock market participation and portfolio composition because money crowdsout other assets at lower levels of wealth. We quantify how changingcorrelations between inflation, real bond and stock returns, and changes inthe inflation process affect household portfolios. Higher mean inflationincreases stock market participation, while portfolios shift to bonds andstocks, and away from money. A negative inflation-bond return correlation,or a positive stock-bond return correlation, reduces the diversificationbenefit from holding bonds, encouraging a higher stock exposure