Optimal Consumption and Equilibrium Prices with Portfolio Cone Constraints and Stochastic Labor Income

Rodney L. White Center for Financial Research Working Paper No. 4-95

Posted: 10 Sep 1999

See all articles by Domenico Cuoco

Domenico Cuoco

University of Pennsylvania - Finance Department

Abstract

This paper examines the individual's consumption and investment problem when labor income follows a general bounded process and the dollar amounts invested in the risky assets are constrained to take values in a given nonempty, closed, convex cone. Short sale constraints, as well as incomplete markets, can be modeled as special cases of this setting. Existence of optimal policies is established using martingale and duality techniques under fairly general assumptions on the security price coefficients and the individual's utility function. This result is obtained by reformulating the individual's dynamic optimization problem as a dual static problem over a space of martingales. An explicit characterization of equilibrium risk premia in the presence of portfolio constraints is also provided. In the unconstrained case, this characterization reduces to Consumption-based Capital Asset Pricing Model.

JEL Classification: G11, G12

Suggested Citation

Cuoco, Domenico, Optimal Consumption and Equilibrium Prices with Portfolio Cone Constraints and Stochastic Labor Income. Rodney L. White Center for Financial Research Working Paper No. 4-95. Available at SSRN: https://ssrn.com/abstract=6162

Domenico Cuoco (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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