Optimal Consumption Under a Habit-Formation Constraint: The Deterministic Case

DOI10.1137/22M1471560MaRDI QIDQ6159082zbMATHOpenAlexFDO

Authors Bahman Angoshtari, Erhan Bayraktar, Virginia R. Young

Publication date 1 June 2023

Published in SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/2012.02277

zbMATH Keywords

free-boundary problemoptimal consumptionoptimal controlconsumption humpaverage past consumptionaddictive habit formation

Mathematics Subject Classification ID

Portfolio theory (91G10) Free boundary problems for PDEs (35R35) Hamilton-Jacobi equations in optimal control and differential games (49L12)

Abstract: We formulate and solve a deterministic optimal consumption problem to maximize the discounted CRRA utility of an individual's consumption-to-habit process assuming she only invests in a riskless market and that she is unwilling to consume at a rate below a certain proportion $alphain(0,1]$ of her consumption habit. Increasing $alpha$, increases the degree of addictiveness of habit formation, with $alpha=0$ (respectively, $alpha=1$) corresponding to non-addictive (respectively, completely addictive) model. We derive the optimal consumption policies explicitly in terms of the solution of a nonlinear free-boundary problem, which we analyze in detail. Impatient individuals (or, equivalently, those with more addictive habits) always consume above the minimum rate; thus, they eventually attain the minimum wealth-to-habit ratio. Patient individuals (or, equivalently, those with less addictive habits) consume at the minimum rate if their wealth-to-habit ratio is below a threshold, and above it otherwise. By consuming patiently, these individuals maintain a wealth-to-habit ratio that is greater than the minimum acceptable level. Additionally, we prove that the optimal consumption path is hump-shaped if the initial wealth-to-habit ratio is either: (1) larger than a high threshold; or (2) below a low threshold and the agent is more risk seeking (that is, less risk averse). Thus, we provide a simple explanation for the consumption hump observed by various empirical studies.

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Cited in

(20)

• Additive habit formation: consumption in incomplete markets with random endowments
• Developing utility functions for optimal consumption in models with habit formation and catching up with the Joneses
• Self-regulatory strength and dynamic optimal purchase
• Consumption--leisure choice with habit formation
• A mean field game approach to relative investment-consumption games with habit formation
• The green golden rule: habit and anticipation of future consumption
• Optimal asset allocation, consumption and retirement time with the variation in habitual persistence
• Optimal investment and consumption under a habit-formation constraint
• A greedy algorithm for habit formation under multiplicative utility
• Optimal portfolio and insurance strategy with biometric risks, habit formation and smooth ambiguity
• Utility maximization with habit formation of interaction
• On the Axiomatization of the Satiation and Habit Formation Utility Models
• Optimal consumption, life insurance and investment decision with habit formation
• Optimal consumption dynamics with non-concave habit-forming utility
• On the concavity of consumption function under habit formation
• Optimal consumption sequences under habit formation and satiation
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• How much and how often: a model of repeated consumption with endogenous consumption frequency
• Utility Maximization with Habit Formation: Dynamic Programming and Stochastic PDEs
• Optimal entry and consumption under habit formation

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