Endogenous Credit, Business Cycle, and Portfolio Selection

32 Pages Posted: 6 Feb 2015 Last revised: 2 Jun 2021

See all articles by Kyoung Jin Choi

Kyoung Jin Choi

University of Calgary - Haskayne School of Business

Hyeng Keun Koo

Ajou University - Department of Business Administration

Byung Hwa Lim

SKK Business School, Department of Fintech, Sungkyunkwan University

Jane Yoo

Ajou University - School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: June 2, 2021

Abstract

We study a continuous-time model of consumption and portfolio selection in which the credit limit is endogenously determined by limited commitment. By using a duality approach, we transform the problem into a dual minimization problem and subsequently into a series of optimal stopping problems. We derive the time-varying endogenous credit limit and optimal consumption and investment strategies in closed form. The model implies that the credit limit is cyclical: it is lower (higher) when the Sharpe ratio is high (low). We also show heterogeneity in optimal strategies: the rich tend to increase consumption and the proportion of risky investment in downturns whereas the poor decrease them.

Keywords: Endogenous Credit, Limited Commitment, Business Cycle, Consumption and Portfolio selection, Regime switching

JEL Classification: C73, D11, D15, G11

Suggested Citation

Choi, Kyoung Jin and Koo, Hyeng Keun and Lim, Byung Hwa and Yoo, Jane, Endogenous Credit, Business Cycle, and Portfolio Selection (June 2, 2021). Available at SSRN: https://ssrn.com/abstract=2560607 or http://dx.doi.org/10.2139/ssrn.2560607

Kyoung Jin Choi

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

HOME PAGE: http://sites.google.com/site/kyoungjinchoiecon/

Hyeng Keun Koo

Ajou University - Department of Business Administration ( email )

206 Worldcup-ro
Yeongtong-gu
Suwon, 443-749
Korea, Republic of (South Korea)

Byung Hwa Lim

SKK Business School, Department of Fintech, Sungkyunkwan University ( email )

Seoul
Korea, Republic of (South Korea)

Jane Yoo (Contact Author)

Ajou University - School of Business ( email )

206 Worldcup-ro
Yeongtong-gu
Suwon
Korea, Republic of (South Korea)

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