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Sensitivity of Optimal Consumption Streams

Author

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  • Martin Herdegen

    (ETH Zurich)

  • Johannes Muhle-Karbe

    (ETH Zurich and Swiss Finance Institute)

Abstract

We study the sensitivity of optimal consumption streams with respect to perturbations of the random endowment. At the leading order, the consumption adjustment does not matter: any choice that matches the budget constraint simply shifts the original utility by the marginal value of the perturbation. Nontrivial results obtain at the next-to-leading order. Here, one first solves the problem for a deterministic perturbation, which leads to a "prognosis measure". The desired consumption adjustment for a general endowment perturbation is in turn given by the conditional expectation of the latter, computed under this measure and appropriately weighted with the conditional expectations of the remaining risk-tolerance.

Suggested Citation

  • Martin Herdegen & Johannes Muhle-Karbe, 2015. "Sensitivity of Optimal Consumption Streams," Swiss Finance Institute Research Paper Series 15-27, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1527
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    File URL: http://ssrn.com/abstract=2643322
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    Cited by:

    1. Martin Herdegen & Johannes Muhle-Karbe, 2018. "Stability of Radner equilibria with respect to small frictions," Finance and Stochastics, Springer, vol. 22(2), pages 443-502, April.

    More about this item

    Keywords

    optimal consumption; random endowment; asymptotic analysis;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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