Optimal Consumption and Savings with Stochastic Income and Recursive Utility

39 Pages Posted: 24 Jan 2015

See all articles by Chong Wang

Chong Wang

Naval Postgraduate School - Graduate School of Business and Public Policy

Neng Wang

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Jinqiang Yang

Shanghai University of Finance and Economics

Date Written: January 20, 2015

Abstract

We develop a tractable continuous-time consumption-savings model for a liquidity-constrained agent who faces both permanent and transitory income shocks under incomplete markets. We derive an explicitly-solved consumption function and show that the marginal (certainty equivalent) value of liquidity measures the effects of financial frictions on welfare. We further analytically characterize steady-state target savings and demonstrate that risk aversion and inter-temporal substitution have very different effects on savings and the dispersions of wealth and consumption.

Keywords: buffer stock; precautionary savings; incomplete markets; borrowing constraints; permanent income; non-expected utility

JEL Classification: G11, G31, E2

Suggested Citation

Wang, Chong and Wang, Neng and Yang, Jinqiang, Optimal Consumption and Savings with Stochastic Income and Recursive Utility (January 20, 2015). Columbia Business School Research Paper No. 15-19. Available at SSRN: https://ssrn.com/abstract=2554573 or http://dx.doi.org/10.2139/ssrn.2554573

Chong Wang

Naval Postgraduate School - Graduate School of Business and Public Policy ( email )

555 Dyer Road
Monterey, CA 93943
United States

Neng Wang (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jinqiang Yang

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, P.R.China, AK Shanghai 200433
China

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