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Smoothness of the Value Function for Optimal Consumption Model with Consumption-Wealth Utility and Borrowing Constraint

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  • Weidong Tian
  • Zimu Zhu

Abstract

This paper studies an optimal consumption-investment problem for an investor whose instantaneous utility depends on both consumption and wealth, and the investor faces a general borrowing constraint that the investment amount in the risky asset does not exceed an exogenous function of the wealth. We show that the value function is second-order smooth and present the optimal consumption-investment policy in a feedback form. Moreover, when the risky investment amount is bounded above by a fixed constant, we show that under certain conditions, the constraint is binding if and only if an endogenous threshold bounds the portfolio wealth, and we determine the endogenous wealth threshold with the smooth fit condition. Our results encompass several well-developed portfolio choice models and imply new applications.

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  • Weidong Tian & Zimu Zhu, 2022. "Smoothness of the Value Function for Optimal Consumption Model with Consumption-Wealth Utility and Borrowing Constraint," Papers 2210.01016, arXiv.org, revised Dec 2023.
    • Handle: RePEc:arx:papers:2210.01016
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    References listed on IDEAS

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