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

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

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    File URL: http://www.sciencedirect.com/science/article/pii/S0165176512004624
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    Bibliographic Info

    Article provided by Elsevier in its journal Economics Letters.

    Volume (Year): 117 (2012)
    Issue (Month): 3 ()
    Pages: 646-649

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    Handle: RePEc:eee:ecolet:v:117:y:2012:i:3:p:646-649

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    Web page: http://www.elsevier.com/locate/ecolet

    Related research

    Keywords: Portfolio selection; Intolerance for decline in consumption; Risk taking; Felicity function;

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    1. 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.
    2. Frank Riedel, 2007. "Optimal consumption choice with intolerance for declining standard of living," Working Papers 394, Bielefeld University, Center for Mathematical Economics.
    3. Dybvig, Philip H, 1995. "Dusenberry's Ratcheting of Consumption: Optimal Dynamic Consumption and Investment Given Intolerance for Any Decline in Standard of Living," Review of Economic Studies, Wiley Blackwell, vol. 62(2), pages 287-313, April.
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