Consumption and portfolio choice under internal multiplicative habit formation
van Bilsen,Servaas Bovenberg,Lans Laeven,R.J.A.
van Bilsen,Servaas
Bovenberg,Lans
Laeven,R.J.A.
Abstract
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 nontrivial linearization to the budget constraint. This enables us to explicitly characterize how habit formation affects the marginal propensity to consume and optimal stock–bond investments. We also show that in a setting that combines habit formation with Epstein–Zin utility, consumption no longer grows at unrealistically high rates at high ages and investments in risky assets decrease.
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Publisher Copyright: Copyright © 2019 Michael G. Foster School of Business, University of Washington.
Date
2020-11-01
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Citation
van Bilsen, S, Bovenberg, L & Laeven, R J A 2020, 'Consumption and portfolio choice under internal multiplicative habit formation', Journal of Financial and Quantitative Analysis, vol. 55, no. 7, pp. 2334 - 2371. https://doi.org/10.1017/S0022109019000772
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info:eu-repo/semantics/closedAccess