Demographic changes can affect economic dynamics in various ways. Little work however has been conducted upon whether and how demographic fluctuations influence capital markets. In an examination of the life-cycle investment hypothesis and the life-cycle aversion hypothesis the authors explore how demographic changes affect capital markets. The life-cycle investment hypothesis states that when people are in their 20s and 30s they tend to favor investing in housing instead of in capital markets. As they age however the demand for housing will stabilize or decrease and the demand for financial assets will rise. The investor will therefore during this later stage of his life allocate a larger proportion of resources toward capital markets and building financial assets. That the stock market should rise as populations age and the housing market declines is supported by empirical evidence for the post-1945 period. Specifically the time-series paths of the average age the real Standard and Poors 500 index and the real price of housing were considered by the authors. The second hypothesis that an investors risk aversion increases with age was then tested by estimating the resulting Euler equation and is also supported during the post-1945 period. An increase in average age is found to predict an increase in risk premiums.
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