Bond Ladders and Optimal Portfolios∗

This paper examines portfolios within the framework of a dynamic asset-pricing model when investors can trade equity assets as well as bonds of many different maturities. We specify the model so that investors have demand for both a risky and a safe income stream. We characterize the resulting optimal equilibrium stock and bond portfolios and document that optimal bond investment strategies partly exhibit a ladder structure, if a sufficient number of bonds is available for trade. The main contribution of the paper is to show that complete ladders with all bonds in the economy combined with a market portfolio of equity assets are nearly optimal investment strategies. This paper therefore provides a rationale for bond ladders as a popular bond investment strategy.