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Optimal consumption under uncertainty, liquidity constraints, and bounded rationality

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  • Ömer Özak

    () (Southern Methodist University)

Abstract

I study how boundedly rational agents can learn a “good” solution to an infinite horizon optimal consumption problem under uncertainty and liquidity constraints. Using an empirically plausible theory of learning I propose a class of adaptive learning algorithms that agents might use to choose a consumption rule. I show that the algorithm always has a globally asymptotically stable consumption rule, which is optimal. Additionally, I present extensions of the model to finite horizon settings, where agents have finite lives and life-cycle income patterns. This provides a simple and parsimonious model of consumption for large agent based models.

Suggested Citation

  • Ömer Özak, 2013. "Optimal consumption under uncertainty, liquidity constraints, and bounded rationality," Departmental Working Papers 1307, Southern Methodist University, Department of Economics.
  • Handle: RePEc:smu:ecowpa:1307
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    References listed on IDEAS

    as
    1. Allen, Todd W. & Carroll, Christopher D., 2001. "Individual Learning About Consumption," Macroeconomic Dynamics, Cambridge University Press, vol. 5(02), pages 255-271, April.
    2. Christopher D. Carroll, 2004. "Theoretical Foundations of Buffer Stock Saving," Economics Working Paper Archive 517, The Johns Hopkins University,Department of Economics.
    3. Loomes, Graham & Sugden, Robert, 1982. "Regret Theory: An Alternative Theory of Rational Choice under Uncertainty," Economic Journal, Royal Economic Society, vol. 92(368), pages 805-824, December.
    4. Selten, Reinhard & Stoecker, Rolf, 1986. "End behavior in sequences of finite Prisoner's Dilemma supergames A learning theory approach," Journal of Economic Behavior & Organization, Elsevier, vol. 7(1), pages 47-70, March.
    5. Borgers, Tilman & Sarin, Rajiv, 1997. "Learning Through Reinforcement and Replicator Dynamics," Journal of Economic Theory, Elsevier, vol. 77(1), pages 1-14, November.
    6. Alexander L. Brown & Zhikang Eric Chua & Colin F. Camerer, 2009. "Learning and Visceral Temptation in Dynamic Saving Experiments," The Quarterly Journal of Economics, Oxford University Press, vol. 124(1), pages 197-231.
    7. Xavier Gabaix, 2014. "A Sparsity-Based Model of Bounded Rationality," The Quarterly Journal of Economics, Oxford University Press, vol. 129(4), pages 1661-1710.
    8. Harald Uhlig & Martin Lettau, 1999. "Rules of Thumb versus Dynamic Programming," American Economic Review, American Economic Association, vol. 89(1), pages 148-174, March.
    9. Christopher D. Carroll, 2001. "A Theory of the Consumption Function, with and without Liquidity Constraints," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 23-45, Summer.
    10. Sargent, Thomas J., 1993. "Bounded Rationality in Macroeconomics: The Arne Ryde Memorial Lectures," OUP Catalogue, Oxford University Press, number 9780198288695.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Adaptive learning models; bounded rationality; dynamic programming; consumption function; behavioral economics; liquidity constraint; saving behavior;

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D9 - Microeconomics - - Micro-Based Behavioral Economics
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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