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A generalization of Dybvig’s result on portfolio selection with intolerance for decline in consumption

Author

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  • Koo, Byung Lim
  • Koo, Hyeng Keun
  • Koo, Jung Lim
  • Hyun, ChongSeok

Abstract

In this note we show the following result of Dybvig (1995) is valid for a general von Neumann–Morgenstern utility function: for an agent who does not tolerate a decline in consumption, the optimal investment out of discretionary wealth (in excess of the perpetuity value of current consumption) in the risky asset does not depend on the risk aversion coefficient of her felicity function locally when she does not adjust her consumption. The homotheticity assumption is not required. An implication of our result is that if an economic agent exhibits non-time-separable preference due to intertemporal linkage of consumption, her risk-taking over a short time period can be independent of her felicity function.

Suggested Citation

  • Koo, Byung Lim & Koo, Hyeng Keun & Koo, Jung Lim & Hyun, ChongSeok, 2012. "A generalization of Dybvig’s result on portfolio selection with intolerance for decline in consumption," Economics Letters, Elsevier, vol. 117(3), pages 646-649.
    • Handle: RePEc:eee:ecolet:v:117:y:2012:i:3:p:646-649
    DOI: 10.1016/j.econlet.2012.08.027
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    References listed on IDEAS

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    1. Philip H. Dybvig, 1995. "Dusenberry's Ratcheting of Consumption: Optimal Dynamic Consumption and Investment Given Intolerance for any Decline in Standard of Living," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 62(2), pages 287-313.
    2. Riedel, Frank, 2009. "Optimal consumption choice with intolerance for declining standard of living," Journal of Mathematical Economics, Elsevier, vol. 45(7-8), pages 449-464, July.
    3. Cox, John C. & Huang, Chi-fu, 1989. "Optimal consumption and portfolio policies when asset prices follow a diffusion process," Journal of Economic Theory, Elsevier, vol. 49(1), pages 33-83, October.
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    Cited by:

    1. Jeon, Junkee & Koo, Hyeng Keun & Shin, Yong Hyun, 2018. "Portfolio selection with consumption ratcheting," Journal of Economic Dynamics and Control, Elsevier, vol. 92(C), pages 153-182.

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    More about this item

    Keywords

    Portfolio selection; Intolerance for decline in consumption; Risk taking; Felicity function;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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