Robustly dynamic tax evasion and consumption with preferences for cash

Pengfei Luo and Yong Ma

International Review of Finance, 2021, vol. 21, issue 3, 1078-1088

Abstract: In this article, we develop a robustly optimal consumption and tax evasion model with recursive utility and preferences for cash. We derive the analytical solutions for the optimal consumption and portfolio rules. We find that in contrast to the agent without preferences for cash, the agent with preferences for cash will reduce the consumption‐wealth ratio, sharply increase tax evasion, reduce the investment in the non‐concealed risky asset, and increase cash reserve. Furthermore, the optimal tax evasion is related to the volatility and the rate of return of the risky asset, as well as the ambiguity aversion and the elasticity of intertemporal substitution, which are inconsistent with the case without preferences for cash. Our results can provide potential explanations for some empirical phenomena.

Date: 2021
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