Optimal consumption and portfolios with the hyperbolic absolute risk aversion preference under the CEV model

Hao Chang, Xueyan Li and Xingjiang Chen

Communications in Statistics - Theory and Methods, 2022, vol. 51, issue 24, 8799-8821

Abstract: This paper studies the optimal investment-consumption decision under the constant elasticity of variance (CEV) model for an individual seeking to maximize the expected utility from cumulative consumption plus the expected utility from terminal wealth. Due to the fact that different individuals may have different risk preferences, we assume that the risk preference of an individual satisfies a hyperbolic absolute risk aversion (HARA) utility function. Generally speaking, power utility function, logarithmic utility function and exponential utility function widely used in investment theory are usually special cases of HARA utility function. By using the principle of dynamic programming and Legendre transform-dual technique, we obtain the explicit expression of the optimal investment-consumption decision. In addition, we derive the results under other utility functions as well and analyze some characteristics of the optimal portfolios and the optimal consumption decisions. A numerical simulation is presented to illustrate our results. Research results suggest that the optimal investment decisions between with consumption behavior and without it have considerable differences.

Date: 2022
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DOI: 10.1080/03610926.2021.1907411

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