Consumption Paths under Prospect Utility in an Optimal Growth Model
AbstractThis paper studies the Cass-Koopmans-Ramsey model of optimal economic growth in the presence of loss aversion and habit formation. The representative agent's preferences for consumption can be gradually varied between the standard constant intertemporal elasticity of substitution (CIES) case and Kahneman and Tversky's prospect utility. We find that the transitional dynamics of optimal consumption paths differ distinctly from the standard model, in particular consumption smoothing is more pronounced. We also show that prospect utility can cause the economy to remain in a steady state with low consumption and low capital.
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Ramsey growth model; prospect theory; loss aversion; optimal consumption;
Other versions of this item:
- Foellmi, Reto & Rosenblatt-Wisch, Rina & Schenk-Hoppé, Klaus Reiner, 2011. "Consumption paths under prospect utility in an optimal growth model," Journal of Economic Dynamics and Control, Elsevier, vol. 35(3), pages 273-281, March.
- Reto FOELLMI & Rina ROSENBLATT-WISCH & Klaus REINER SCHENK-HOPPE, . "Consumption Paths under Prospect Utility in an Optimal Growth Model," Swiss Finance Institute Research Paper Series 10-38, Swiss Finance Institute.
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
- O41 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-10-16 (All new papers)
- NEP-DGE-2010-10-16 (Dynamic General Equilibrium)
- NEP-FDG-2010-10-16 (Financial Development & Growth)
- NEP-UPT-2010-10-16 (Utility Models & Prospect Theory)
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