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Consumption and Portfolio Rules with Stochastic Quasi-Hyperbolic Discounting

24 Pages Posted: 26 May 2011  

Ignacio Isabel Palacios-Huerta

London School of Economics

Alonso Pérez-Kakabadse

London School of Economics & Political Science (LSE) - Department of Economics; Moore Capital Management

Date Written: January 1, 2011

Abstract

We investigate the joint consumption-saving and portfolio-selection problem under capital risk, assuming sophisticated but time-inconsistent agents. We introduce stochastic hyperbolic preferences as specified in Harris and Laibson (2008) and find closed-form solutions for the classic Merton (1969, 1971) optimal consumption and portfolio selection problem in continuous time. The portfolio rule remains identical to the time-consistent solution with power utility with no borrowing constraints. However, the marginal propensity to consume out of wealth is unambiguously greater than the time-consistent, exponential case.

Suggested Citation

Palacios-Huerta, Ignacio Isabel and Pérez-Kakabadse, Alonso, Consumption and Portfolio Rules with Stochastic Quasi-Hyperbolic Discounting (January 1, 2011). Available at SSRN: https://ssrn.com/abstract=1465110 or http://dx.doi.org/10.2139/ssrn.1465110

Ignacio Palacios-Huerta

London School of Economics ( email )

Dept. of Management
Houghton Street
London, WC2A 2AE
United Kingdom

Alonso Pérez-Kakabadse (Contact Author)

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Moore Capital Management

1 Curzon Street
London, W1J 5HA
United Kingdom

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