Robust Solutions to the Life-Cycle Consumption Problem

Lorenzo Reus () and Frank J. Fabozzi ()
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Lorenzo Reus: Universidad Adolfo Ibañez
Frank J. Fabozzi: EDHEC Business School

Computational Economics, 2021, vol. 57, issue 2, No 3, 499 pages

Abstract: Abstract This paper demonstrates how the well-known discrete life-cycle consumption problem (LCP) can be solved using the Robust Counterpart (RC) formulation technique, as defined in Ben-Tal and Nemirovski (Math Oper Res 23(4):769–805, 1998). To do this, we propose a methodology that involves applying a change of variables over the original consumption before deriving the RC. These transformations allow deriving a closed solution to the inner problem, and thus to solve the LCP without facing the curse of dimensionality and without needing to specify the prior distribution for the investment opportunity set. We generalize the methodology and illustrate how it can be used to solve other type of problems. The results show that our methodology enables solving long-term instances of the LCP (30 years). We also show it provides an alternative consumption pattern as to the one provided by a benchmark that uses a dynamic programming approach. Rather than finding a consumption that maximizes the expected lifetime utility, our solution delivers higher utilities for worst-case scenarios of future returns.

Keywords: Life-cycle consumption problem; Intertemporal portfolio-choice problem; Robust optimization; Robust counterpart framework (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s10614-019-09964-1

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