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Climbing the income ladder: Search and investment in a regime-switching affine income model

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  • Serrano, Rafael

Abstract

We study search and investment in an income ladder setting modeled by a regime-switching affine jump–diffusion income process with transition rates controlled by costly sequential search effort . The agent has exponential utility and can invest in a risky asset possibly correlated with the income process. Optimal policies are characterized explicitly, which allows us to identify the impact of risk aversion, search frictions, investment, and income risk in the agent’s decisions. We illustrate our results with numerical examples. In particular, we find that search effort is reduced as the income mean-reversion increases or the hedging opportunities the financial markets offer increase.

Suggested Citation

  • Serrano, Rafael, 2023. "Climbing the income ladder: Search and investment in a regime-switching affine income model," Finance Research Letters, Elsevier, vol. 58(PA).
    • Handle: RePEc:eee:finlet:v:58:y:2023:i:pa:s154461232300702x
    DOI: 10.1016/j.frl.2023.104330
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    More about this item

    Keywords

    Optimal search; Stochastic income; Affine processes; Regime-switching;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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