First Order Loss Aversion and Optimal Consumption

15 Pages Posted: 25 Sep 2015

See all articles by John G. Watson

John G. Watson

Financial Engines, Inc.; Stanford Graduate School of Business

Jason S. Scott

Financial Engines, Inc.

Date Written: September 23, 2015

Abstract

We consider a model for utility over consumption with first order loss aversion and look at its properties. We find consumption strategies that maximize expected utility for complete markets with pricing kernels generated by Levy processes. Both the discrete-time and continuous-time consumption strategies are illustrated. When loss aversion vanishes, we recover the Samuelson-Merton solution, and when loss aversion becomes infinite, we recover the Duesenberry-Dybvig solution.

Keywords: First order loss aversion, Expected utility maximization

JEL Classification: D91

Suggested Citation

Watson, John G. and Scott, Jason S., First Order Loss Aversion and Optimal Consumption (September 23, 2015). Available at SSRN: https://ssrn.com/abstract=2664820 or http://dx.doi.org/10.2139/ssrn.2664820

John G. Watson (Contact Author)

Financial Engines, Inc. ( email )

1050 Enterprise Way
Sunnyvale, CA 94089
United States

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305
United States

Jason S. Scott

Financial Engines, Inc. ( email )

1050 Enterprise Way, 3rd Floor
Sunnyvale, CA 94089
United States

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