Ratchet vs Blase Investors and Asset Markets
39 Pages Posted: 6 May 2004
Date Written: February 2004
This paper proposes a new wealth-dependent utility function for the inter-temporal consumption and portfolio problem, in which the reference (bliss) consumption level is a function of wealth. Ratchet effects obtain when higher wealth increases the reference consumption level; blase behavior occurs when higher wealth reduces it. We have three contributions: (i) we identify closed-form solutions for optimal consumption and portfolio rules; (ii) we use the optimal rules to estimate the model using aggregate portfolio data, and (iii) we derive and discuss the pricing implications of our results. Our estimates are consistent with blase behavior and counter-cyclical risk aversion.
Keywords: Asset pricing, Portfolio Choice, Equity premium, Risk-free rate, Predictability, Wealth-dependent preferences, Preference for Status, Reference Consumption Levels
JEL Classification: G11, G12
Suggested Citation: Suggested Citation