Consumption and portfolio rules whit stochastic hyperbolic discounting

Ignacio Palacios Huerta and Alonso Pérez Kakabadse
Authors registered in the RePEc Author Service: Ignacio Palacios-Huerta

IKERLANAK from Universidad del País Vasco - Departamento de Fundamentos del Análisis Económico I

Abstract: We extend the classic Merton (1969, 1971) problem that investigates the joint consumption-savings and portfolio-selection problem under capital risk by assuming sophisticated but time-inconsistent agents. We introduce stochastic hyperbolic preferences as in Harris and Laibson (2013) and find closed-form solutions for Merton's optimal consumption and portfolio selection problem in continuous time. We find that the portfolio rule remains identical to the time-consistent solution with power utility and no borrowing constraints. However,the marginal propensity to consume out of wealth is unambiguously greater than the time-consistent, exponential case and,importantly, it is also more responsive to changes in risk. These results suggest that hyperbolic discounting with sophisticated agents offers promise for contributing to explaining important aspects of asset market data.

Keywords: consumption; savings; portfolio choice; risk; hyperbolic discounting (search for similar items in EconPapers)
Date: 2013-09
New Economics Papers: this item is included in nep-ore
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Citations: View citations in EconPapers (6)

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Dpto. de Fundamentos del Análisis Económico I, Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain

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