Population Aging and Financial Markets

A number of financial market analysts have argued that the aging of the “Baby Boom” cohort contributed to the rise U.S. asset values during the 1990s, and that asset prices will decline when this group reaches retirement age and begins to draw down its wealth. Similar arguments can be raised for other nations that face analogous demographic transitions over the next half century. This paper explores the importance of changing demographic structure for asset returns, asset prices, and the composition of household balance sheets in the United States. The paper begins by discussing the theoretical basis for a link between asset markets and the age structure of the population. Standard models suggest that equilibrium returns on financial assets will vary in response to changes in population age structure, although the empirical magnitude of such effects is very difficult to predict with precision. While the direction of the effect of demographic changes is not controversial, the importance of such changes for financial markets is open to debate. The paper presents several strands of empirical evidence that bear on this issue. First, it reports an empirical analysis of the current age-specific patterns of asset holding in the United States, with the goal of understanding the age-wealth trajectory and how it may affect the future demand for financial assets. Data on age-wealth profiles from repeated cross-sections of the Survey of Consumer Finances suggest that asset holdings rise sharply when households are in their 30s and 40s. Aside from the automatic decline in the value of defined benefit pension assets as households age, however, other financial assets decline only gradually when households are in their retirement years. When these data are used to project asset demands in light of the future age structure of the U.S. population, they do not show a sharp decline in asset demand between 2020 and 2050. This finding calls into question the “asset market meltdown” view. Similar arguments are likely to apply in other nations where elderly households exhibit substantial saving rates. Second, the paper considers the historical association between population age structure and real returns on Treasury bills, long-term government bonds, and corporate stock. The evidence suggests only modest effects, if any, of demographics on returns. This is partly due to the limited power of statistical tests based on the few effective degrees of freedom in the historical record of age structure and asset returns. There is more evidence of a historical correlation between measures of asset levels, such as the price-dividend ratio, and summary measures of the population age structure, although once again the results are sensitive to choices about econometric specification. These empirical findings provide modest support, at best, for the view that asset prices could decline as the share of households over the age of 65 increases. Finally, the paper concludes with a discussion of the types of financial assets that will experience rising demand, and the types that will face declining demand, as the U.S. population and the population in other developed nations ages.