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Portfolio Choice and Permanent Income

Author

Listed:
  • Stanley Zin
  • Thomas Tallarini

Abstract

We solve the optimal saving/portfolio-choice problem in an intertemporal recursive utility framework. Our solution to this problem is sufficiently general to allow (i) risk aversion to vary independently of intertemporal substitution, (ii) many risky assets, (iii) stochastic labor income that may be correlated with asset returns and/or follow life-cycle patterns, and (iv) portfolio adjustment costs. We use Weil's (1993) isoelastic/constant absolute risk averse model as a starting point. We use perturbation methods around this analytical solution to derive decision rules for consumption and portfolios. Unlike previous models that have been solved by these methods, our baseline case is explicitly stochastic. In addition, since the portfolio choice is indeterminate in the baseline, we apply bifurcation methods to center our approximation for the portfolio rule.

Suggested Citation

  • Stanley Zin & Thomas Tallarini, 2005. "Portfolio Choice and Permanent Income," Computing in Economics and Finance 2005 408, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:408
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    More about this item

    Keywords

    Portfolio choice; permanent income hypothesis; perturbation methods;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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