Portfolio and Consumption Choice with Stochastic Investment Opportunities and Habit Formation in Preferences PDF Download
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Author: Claus Munk
Publisher:
ISBN:
Category :
Languages : en
Pages : 43
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Book Description
We study the dynamic consumption and portfolio choice of an investor who has habit formation in preferences and access to a complete financial market. For general, possibly non-Markov, dynamics of market prices, we provide an exact characterization of the optimal behavior in terms of two relatively simple and intuitively interpretable stochastic processes. We study in more detail the optimal strategies in two concrete examples of time-varying investment opportunities. Firstly, we derive a closed-form solution of the optimal consumption and portfolio choice with mean-reverting stock returns. Secondly, with Cox-Ingersoll-Ross interest rate dynamics we can express the optimal strategies in terms of the solution to a partial differential equation, which has an explicit solution for time-additive preferences, but not with habit formation. Our numerical examples show that, while hedging demands for various assets are affected differently by habit persistence, the main effect on relative asset allocations stems from the fact that some assets (bonds and cash) are better investment objects than others (stocks) when it comes to ensuring that future consumption will not fall below the habit level. The implications of habit persistence in models with labor income are also addressed.
Author: Claus Munk
Publisher:
ISBN:
Category :
Languages : en
Pages : 43
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Book Description
We study the dynamic consumption and portfolio choice of an investor who has habit formation in preferences and access to a complete financial market. For general, possibly non-Markov, dynamics of market prices, we provide an exact characterization of the optimal behavior in terms of two relatively simple and intuitively interpretable stochastic processes. We study in more detail the optimal strategies in two concrete examples of time-varying investment opportunities. Firstly, we derive a closed-form solution of the optimal consumption and portfolio choice with mean-reverting stock returns. Secondly, with Cox-Ingersoll-Ross interest rate dynamics we can express the optimal strategies in terms of the solution to a partial differential equation, which has an explicit solution for time-additive preferences, but not with habit formation. Our numerical examples show that, while hedging demands for various assets are affected differently by habit persistence, the main effect on relative asset allocations stems from the fact that some assets (bonds and cash) are better investment objects than others (stocks) when it comes to ensuring that future consumption will not fall below the habit level. The implications of habit persistence in models with labor income are also addressed.
Author: Servaas van Bilsen
Publisher:
ISBN:
Category :
Languages : en
Pages : 51
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Book Description
This paper explores the optimal consumption and investment behavior of an individual who derives utility from the ratio between his consumption and an endogenous habit. We obtain closed-form policies under general utility functionals and stochastic investment opportunities, by developing a non-trivial linearization to the budget constraint. This enables us to explicitly characterize how habit formation a ffects the marginal propensity to consume and optimal stock-bond investments. We also show that in a setting which combines habit formation with Epstein-Zin utility, consumption no longer grows at unrealistically high rates at high ages and investments in risky assets decrease.
Author: Francisco J. Gomes
Publisher:
ISBN:
Category : Asset allocation
Languages : en
Pages : 64
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Book Description
Author: Francisco Gomes
Publisher:
ISBN:
Category :
Languages : en
Pages : 52
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Book Description
Motivated by the success of internal habit formation preferences in explaining asset pricing puzzles, we introduce these preferences in a life-cycle model of consumption and portfolio choice with liquidity constraints, undiversifiable labor income risk and stock-market participation costs. In contrast to the initial motivation, we find that the model is not able to simultaneously match two very important stylized facts: A low stock market participation rate, and moderate equity holdings for those households that do invest in stocks. Habit formation increases wealth accumulation because the intertemporal consumption smoothing motive is stronger. As a result, households start participating in the stock market very early in life, and invest their portfolios almost fully in stocks. Therefore, we conclude that, with respect to its ability to match the empirical evidence on asset allocation behavior, the internal habit formation model is dominated by its time-separable utility counterpart.
Author: Kerry Back
Publisher: Oxford University Press
ISBN: 0190241144
Category : Business & Economics
Languages : en
Pages : 745
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Book Description
Today all would agree that Mexico and the United States have never been closer--that the fates of the two republics are intertwined. Mexico has become an intimate part of life in almost every community in the United States, through immigration, imported produce, business ties, or illegal drugs. It is less a neighbor than a sibling; no matter what our differences, it is intricately a part of our existence. In the fully updated second edition of Mexico: What Everyone Needs to Know(R), Roderic Ai Camp gives readers the most essential information about our sister republic to the south. Camp organizes chapters around major themes--security and violence, economic development, foreign relations, the colonial heritage, and more. He asks questions that take us beyond the headlines: Why does Mexico have so much drug violence? What was the impact of the North American Free Trade Agreement? How democratic is Mexico? Who were Benito Juarez and Pancho Villa? What is the PRI (the Institutional Revolutionary Party)? The answers are sometimes surprising. Despite ratification of NAFTA, for example, Mexico has fallen behind Brazil and Chile in economic growth and rates of poverty. Camp explains that lack of labor flexibility, along with low levels of transparency and high levels of corruption, make Mexico less competitive than some other Latin American countries. The drug trade, of course, enhances corruption and feeds on poverty; approximately 450,000 Mexicans now work in this sector. Brisk, clear, and informed, Mexico: What Everyone Needs To Know(R) offers a valuable primer for anyone interested in the past, present, and future of our neighbor to the South. Links to video interviews with prominent Mexicans appear throughout the text. The videos can be accessed at through The Oxford Research Encyclopedia of Latin American History at http: //latinamericanhistory.oxfordre.com/page/videos/
Author: Mark D. Schroder
Publisher:
ISBN:
Category :
Languages : en
Pages : 32
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Book Description
We show an isomorphism between optimal portfolio selection or competitive equilibrium models with utilities incorporating linear habit formation, and corresponding models without habit formation. The isomorphism is expressed through an explicit transformation of consumption plans, utilities, endowments, state prices, wealth processes, security prices, and trading strategies that can be used to mechanically transform known solutions not involving habit formation to corresponding solutions with habit formation. For example, the Constantinides (1990) and Ingersoll (1992) solutions are mechanically obtained from the familiar Merton solutions for the additive utility case, without recourse to a Bellman equation or first order conditions. More generally, recent solutions to portfolio selection problems with recursive utility and a stochastic investment opportunity set are readily transformed to novel solutions of corresponding problems with utility that combines recursivity with habit formation. Our methodology also applies in the context of Hindy-Huang-Kreps preferences, where our isomorphism shows that the solution obtained by Hindy and Huang (1993) can be mechanically transformed to Dybvig's (1995) solution to the optimal consumption-investment problem with consumption ratcheting.
Author: Valery Polkovnichenko
Publisher:
ISBN:
Category :
Languages : en
Pages : 42
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Book Description
This paper explores the implications of the additive and endogenous habit formation preferences in the context of a life-cycle model of an investor who has stochastic uninsurable labor income. To solve the model, I analytically derive the habit - wealth feasibility constraints and show that they depend on the worst possible path of future labor income and on the habit strength, but not on the probability of the worst income. When there is only a slim chance of a severe income shock, the model implies much more conservative portfolios. The model also predicts that for some low to moderately wealthy households, the portfolio share allocated to stocks increases with wealth. Because of this feature, the model can generate more conservative portfolios for younger than for middle-aged households. One controversial finding is that for high values of the habit strength parameter, usually required for the resolution of asset pricing puzzles in general equilibrium, the life-cycle model predicts counterfactually high wealth accumulation.
Author: Bjarne S. Jensen
Publisher: Copenhagen Business School Press DK
ISBN: 9788763001854
Category : Business & Economics
Languages : en
Pages : 464
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Book Description
This book analyzes stochastic dynamic systems across a broad spectrum in economics and finance. The major unifying theme is the coherent and rigorous treatment of uncertainty and its implications for describing stochastic processes by the stochastic differential equations of the fundamental models in various fields. Pertinent subjects are interrelated, juxtaposed, and examined for consistency in theoretical and empirical contexts. The volume consists of three parts: Developments in Stochastic Dynamics; Stochastic Dynamics in Basic Economic Growth Models; and Intertemporal Optimization in Consumption, Finance, and Growth. Key topics include: fractional Brownian motion in finance; moment evolution of Gaussian and geometric Wiener diffusions; stochastic kinematics and stochastic mechanics; stochastic growth in continuous time; time delays and Hopf bifurcation; consumption and investment strategies; differential systems in finance and life insurance; uncertainty of technological innovations; investment and employment cycles; stochastic control theory; and risk aversion. The works collected in this book serves to bridge the "old" deterministic dynamics and the "new" stochastic dynamics. The collection is important for scholars and advanced graduate students of economics, statistics, and applied mathematics.
Author: Yoel Lax
Publisher:
ISBN:
Category :
Languages : en
Pages : 106
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Book Description
Author: Philipp Karl Illeditsch
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
In the Ơ̐1rst essay, I decompose inƠ̐2ation risk into (i) a part that is correlated with real returns on the market portfolio and factors that determine investor0́9s preferences and investment opportunities and (ii) a residual part. I show that only the Ơ̐1rst part earns a risk premium. All nominal Treasury bonds, including the nominal money-market account, are equally exposed to the residual part except inƠ̐2ation-protected Treasury bonds, which provide a means to hedge it. Every investor should put 100% of his wealth in the market portfolio and inƠ̐2ation-protected Treasury bonds and hold a zero-investment portfolio of nominal Treasury bonds and the nominal money market account. In the second essay, I solve the dynamic asset allocation problem of Ơ̐1nite lived, constant relative risk averse investors who face inƠ̐2ation risk and can invest in cash, nominal bonds, equity, and inƠ̐2ation-protected bonds when the investment opportunityset is determined by the expected inƠ̐2ation rate. I estimate the model with nominal bond, inƠ̐2ation, and stock market data and show that if expected inƠ̐2ation increases, then investors should substitute inƠ̐2ation-protected bonds for stocks and they should borrow cash to buy long-term nominal bonds. In the lastessay, I discuss how heterogeneity in preferences among investors withexternal non-addictive habit forming preferences aƠ̐0ects the equilibrium nominal term structure of interest rates in a pure continuous time exchange economy and complete securities markets. Aggregate real consumption growth and inƠ̐2ation are exogenously speciƠ̐1ed and contain stochastic components thataƠ̐0ect their means andvolatilities. There are two classes of investors who have external habit forming preferences and diƠ̐0erent localcurvatures oftheir utility functions. The eƠ̐0ects of time varying risk aversion and diƠ̐0erent inƠ̐2ation regimes on the nominal short rate and the nominal market price of risk are explored, and simple formulas for nominal bonds, real bonds, and inƠ̐2ation risk premia that can be numerically evaluated using Monte Carlo simulation techniques are provided.
