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Optimal investor life cycle decisions with time-inconsistent preferences

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  • Chen, Shumin
  • Luo, Dan
  • Yao, Haixiang

Abstract

We examine the lifetime decisions of an investor with time-inconsistent preferences, obtaining optimal time-consistent strategies for investment, consumption, and life insurance premiums explicitly under a stationary Markov perfect equilibrium framework. We find that the investor increases consumption to seek immediate gratification, and simultaneously increases life insurance purchasing to fulfill a legacy need. However, at a later stage in the life cycle, the investor confronts slower wealth accumulation and reduces consumption and life insurance purchasing accordingly. We also investigate the effects of naivete, degree of time inconsistency, risk preferences, legacy weight, insurance cost, death duty, and labor income on the investor's decision making. Our study reveals the balance of consumption, bequest, and terminal wealth motives in life cycle decisions featuring microfounded bequest utility and stochastic labor income.

Suggested Citation

  • Chen, Shumin & Luo, Dan & Yao, Haixiang, 2024. "Optimal investor life cycle decisions with time-inconsistent preferences," Journal of Banking & Finance, Elsevier, vol. 161(C).
    • Handle: RePEc:eee:jbfina:v:161:y:2024:i:c:s0378426624000359
    DOI: 10.1016/j.jbankfin.2024.107115
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    Keywords

    Time-inconsistent preferences; Life cycle decisions; Dynamic programming; Markov perfect equilibrium; Life insurance;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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