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Strategic Consumption-Portfolio Rules with Informational Frictions

Luo, Yulei (2014): Strategic Consumption-Portfolio Rules with Informational Frictions.

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Abstract

This paper provides a tractable continuous-time CARA-Gaussian framework to explore how the interactions of risk aversion and induced uncertainty due to informational frictions determine strategic consumption-portfolio rules, precautionary savings, and consumption dynamics in the presence of uninsurable labor income. Specifically, after solving the model explicitly, we explore the relative importance of the two types of induced uncertainty: (i) model uncertainty due to robustness and (ii) state uncertainty due to limited information-processing capacity as well as risk aversion in determining asset allocation, precautionary savings, and consumption dynamics. Finally, we discuss how the separation between risk aversion and intertemporal substitution affects strategic asset allocation and precautionary savings.

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