Investment, Income, and Incompleteness
30 Pages Posted: 16 Feb 2009
Date Written: February 15, 2009
The utility-maximizing consumption and investment strategy of an individual investor receiving an unspanned labor income stream seems impossible to find in closed form and very difficult to find using numerical solution techniques. We suggest an easy procedure for finding a specific, simple, and admissible consumption and investment strategy, which is near-optimal in the sense that the wealth-equivalent loss compared to the unknown optimal strategy is very small. We first explain and implement the strategy in a simple setting with constant interest rates, a single risky asset, and an exogenously given income stream, but we also show that the success of the strategy is robust to changes in parameter values, to the introduction of stochastic interest rates, and to endogenous labor supply decisions.
Keywords: Optimal consumption and investment, labor income, incomplete markets, artificially completed markets, welfare loss
JEL Classification: G11
Suggested Citation: Suggested Citation