Portfolio And Consumption Choice With Habit Formation Under Inflation
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| Author | : Frank De Jong |
| Publisher | : |
| Total Pages | : 39 |
| Release | : 2013 |
| Genre | : |
| ISBN | : |
We investigate the optimal portfolio and consumption policies for a finite-horizon investor in a life-cycle model with habit formation and inflation risk. We consider two types of habit investors: one forms habit based on real past consumption, while the other on nominal past consumption, which is motivated by money illusion. The optimal strategy is expressed explicitly in terms of the solution to a linear partial differential equation. We find that the effects of inflation on the optimal strategy depend on the type of habit investor, because it determines the risk profile of the hedge portfolio and subsistence portfolio. This dependence is robust to the incompleteness of the financial market.
| Author | : Ayman Hindy |
| Publisher | : |
| Total Pages | : |
| Release | : 2005 |
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| ISBN | : |
We study a model of consumption choice and portfolio allocation that captures, in two different interpretations, the combined effect of local substitution and habit formation and the combined effect of durability of consumption goods and habit formation over service flows from those goods. In a third interpretation, the model captures the idea of a dual purpose commodity. The optimal allocation problem is from the class of free boundary singular control problems. We discuss, formally, necessary, and sufficient conditions for a consumption and portfolio policy to be optimal. We also introduce a numerical technique based on approximating the original program by a sequence of discrete parameter Markov chain control problems. We provide convergence results of the value function, the optimal investment policy, and the optimal consumption regions in the approximating discrete control problems to those in the original continuous time dynamic program. We construct numerically the consumption boundary that divides the state space into two regions - one of immediate consumption and the other of abstinence. We show that both the wealth required to start consuming and the optimal fraction of wealth invested in the risky asset are cyclical functions in both the stock of the durable good and the standard of living. This is due to the interaction between the durability and habit formation effects. We also study the effect of the cyclical investment behavior on the equilibrium risk premium in a representative consumer economy.
| Author | : Claus Munk |
| Publisher | : |
| Total Pages | : 43 |
| Release | : 2002 |
| Genre | : |
| ISBN | : |
We study the dynamic consumption and portfolio choice of an investor who has habit formation in preferences and access to a complete financial market. For general, possibly non-Markov, dynamics of market prices, we provide an exact characterization of the optimal behavior in terms of two relatively simple and intuitively interpretable stochastic processes. We study in more detail the optimal strategies in two concrete examples of time-varying investment opportunities. Firstly, we derive a closed-form solution of the optimal consumption and portfolio choice with mean-reverting stock returns. Secondly, with Cox-Ingersoll-Ross interest rate dynamics we can express the optimal strategies in terms of the solution to a partial differential equation, which has an explicit solution for time-additive preferences, but not with habit formation. Our numerical examples show that, while hedging demands for various assets are affected differently by habit persistence, the main effect on relative asset allocations stems from the fact that some assets (bonds and cash) are better investment objects than others (stocks) when it comes to ensuring that future consumption will not fall below the habit level. The implications of habit persistence in models with labor income are also addressed.
| Author | : Servaas van Bilsen |
| Publisher | : |
| Total Pages | : 51 |
| Release | : 2018 |
| Genre | : |
| ISBN | : |
This paper explores the optimal consumption and investment behavior of an individual who derives utility from the ratio between his consumption and an endogenous habit. We obtain closed-form policies under general utility functionals and stochastic investment opportunities, by developing a non-trivial linearization to the budget constraint. This enables us to explicitly characterize how habit formation a ffects the marginal propensity to consume and optimal stock-bond investments. We also show that in a setting which combines habit formation with Epstein-Zin utility, consumption no longer grows at unrealistically high rates at high ages and investments in risky assets decrease.
| Author | : Ayman Hindy |
| Publisher | : Forgotten Books |
| Total Pages | : 58 |
| Release | : 2018-03 |
| Genre | : Business & Economics |
| ISBN | : 9780656508983 |
Excerpt from Optimal Consumption and Portfolio Rules With Durability and Habit Formation We entertain three different economic ideas in three different interpretations of the model specified in and In one interpretation, preferences given by (1) exhibit the notions of local substitution and habit formation. Agents with such preferences treat consumptions at adjacent dates as close substitutes and consumptions at distant dates as complements. In a second interpretation, the model represents habit forming preferences over the service flows from irreversible purchases of a durable good that decays over time. In the third interpretation, the model represents preferences for consumption of a dual purpose commodity that provides the agent with two sources of utility. The two components of such a composite good, however, have different half - lives. About the Publisher Forgotten Books publishes hundreds of thousands of rare and classic books. Find more at www.forgottenbooks.com This book is a reproduction of an important historical work. Forgotten Books uses state-of-the-art technology to digitally reconstruct the work, preserving the original format whilst repairing imperfections present in the aged copy. In rare cases, an imperfection in the original, such as a blemish or missing page, may be replicated in our edition. We do, however, repair the vast majority of imperfections successfully; any imperfections that remain are intentionally left to preserve the state of such historical works.
| Author | : Francisco Gomes |
| Publisher | : |
| Total Pages | : 52 |
| Release | : 2008 |
| Genre | : |
| ISBN | : |
Motivated by the success of internal habit formation preferences in explaining asset pricing puzzles, we introduce these preferences in a life-cycle model of consumption and portfolio choice with liquidity constraints, undiversifiable labor income risk and stock-market participation costs. In contrast to the initial motivation, we find that the model is not able to simultaneously match two very important stylized facts: A low stock market participation rate, and moderate equity holdings for those households that do invest in stocks. Habit formation increases wealth accumulation because the intertemporal consumption smoothing motive is stronger. As a result, households start participating in the stock market very early in life, and invest their portfolios almost fully in stocks. Therefore, we conclude that, with respect to its ability to match the empirical evidence on asset allocation behavior, the internal habit formation model is dominated by its time-separable utility counterpart.
| Author | : Yoel Lax |
| Publisher | : |
| Total Pages | : 106 |
| Release | : 2001 |
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| Author | : Mao-Wei Hung |
| Publisher | : |
| Total Pages | : 25 |
| Release | : 2009 |
| Genre | : |
| ISBN | : |
We solve for an intertemporal portfolio-consumption choice problem under inflation. We assume that the nominal interest rate is observable while the expected inflation rate is not. The inclusion of the indexed bond in the investor's portfolio provides the investor an opportunity to perfectly hedge against the inflation risk. While the hedging demand of the nominal bonds would be crowded out proportional to the demand of the indexed bonds. The estimation risk of the estimated inflation rate would also introduce an additional hedging demand. We also show that the direction in which the interest rate and the inflation rate affect the optimal consumption-wealth ratio would rely on the elasticity of intertemporal substitution of the investor. When the elasticity of intertemporal substitution is smaller than one, the consumption-wealth ratio is increasing in the nominal interest rate and decreasing in the inflation rate; the income effect dominates. When the elasticity of intertemporal substitution is greater than one, the consumption-wealth ratio is affected in an opposite way; the substitution effect dominates. However, the consumption-wealth ratio is not decided by the real interest rate, i.e., the difference of the nominal interest rate and the inflation rate. It also depends on the absolute levels of the nominal interest rate and the inflation rate. The nominal and real consumption growth rates are derived. The nominal consumption growth is decided by the sum of the real consumption growth rate and inflation rate.
| Author | : Joseph P. Lupton |
| Publisher | : |
| Total Pages | : 394 |
| Release | : 2002 |
| Genre | : |
| ISBN | : |
| Author | : Jérôme Detemple |
| Publisher | : |
| Total Pages | : 36 |
| Release | : 1989 |
| Genre | : Capital assets pricing model |
| ISBN | : |
