Approximate analytical solutions for consumption/investment problems under recursive utility and finite horizon

Carlos Heitor Campania and René Garcia
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Carlos Heitor Campania: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement

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Abstract: We study the asset allocation and consumption decisions of an investor with recursive utility and a finite investment horizon. We provide an approximate analytical solution under a stochastic investment opportunity set. The solution becomes exact when the elasticity of intertemporal substitution is equal to one or under a constant opportunity set. We show that this elasticity impacts both consumption and portfolio strategies, indicating the importance of disentangling intertemporal substitution from risk aversion. The investor's horizon also plays a crucial role in optimal policies and the usual infinite horizon framework is inappropriate for investors having short- or medium-term horizons. Moreover, the infinite horizon problem reveals the existence of conditions on the preference parameters for our solution to hold, raising the question of whether another solution may exist or not. On its turn, the absence of a bequest motive in the finite horizon problem imposes another condition on risk parameters.

Keywords: Intertemporal hedging; Finite horizon; Stochastic differential utility; Exact analytical solution; Approximate analytical solution (search for similar items in EconPapers)
Date: 2019-04
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Citations: View citations in EconPapers (4)

Published in North American Journal of Economics and Finance, 2019, 48, pp.364-384. ⟨10.1016/j.najef.2019.03.005⟩

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Journal Article: Approximate analytical solutions for consumption/investment problems under recursive utility and finite horizon (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02894663

DOI: 10.1016/j.najef.2019.03.005

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