Robust Consumption and Portfolio Choice with Habit Formation, the Spirit of Capitalism and Recursive Utility

This paper studies consumption and portfolio choice with habit formation, the spirit of capitalism, recursive utility and robustness in a continuous-time stochastic model and examines how the four factors affect consumption and portfolio choice, consumption dynamics and asset pricing. The explicit solu- tions of the robust consumption and portfolio choice problem are obtained, the implications of the four factors for consumption and portfolio choice are dis- cussed, and then the dynamics of consumption and the formula of asset pricing are derived. It is shown that the combined effects of habit formation which stems from past consumption, the spirit of capitalism which endows investors with direct wealth preferences, recursive utility which allows the separation of risk aversion and intertemporal substitution and robustness which takes account of model uncertainty can better interpret the consumption smooth- ing puzzle and the equity premium puzzle than cases which only consider one factor.