IDEAS home Printed from https://ideas.repec.org/a/eee/finlet/v58y2023ipas154461232300702x.html
   My bibliography  Save this article

Climbing the income ladder: Search and investment in a regime-switching affine income model

Author

Listed:
  • Serrano, Rafael

Abstract

We study search and investment in an income ladder setting modeled by a regime-switching affine jump–diffusion income process with transition rates controlled by costly sequential search effort . The agent has exponential utility and can invest in a risky asset possibly correlated with the income process. Optimal policies are characterized explicitly, which allows us to identify the impact of risk aversion, search frictions, investment, and income risk in the agent’s decisions. We illustrate our results with numerical examples. In particular, we find that search effort is reduced as the income mean-reversion increases or the hedging opportunities the financial markets offer increase.

Suggested Citation

  • Serrano, Rafael, 2023. "Climbing the income ladder: Search and investment in a regime-switching affine income model," Finance Research Letters, Elsevier, vol. 58(PA).
    • Handle: RePEc:eee:finlet:v:58:y:2023:i:pa:s154461232300702x
    DOI: 10.1016/j.frl.2023.104330
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S154461232300702X
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.frl.2023.104330?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Xavier Gabaix & Jean‐Michel Lasry & Pierre‐Louis Lions & Benjamin Moll, 2016. "The Dynamics of Inequality," Econometrica, Econometric Society, vol. 84, pages 2071-2111, November.
    2. Wang, Chong & Wang, Neng & Yang, Jinqiang, 2016. "Optimal consumption and savings with stochastic income and recursive utility," Journal of Economic Theory, Elsevier, vol. 165(C), pages 292-331.
    3. Christopher A. Pissarides & Barbara Petrongolo, 2001. "Looking into the Black Box: A Survey of the Matching Function," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 390-431, June.
    4. Alfonso A. Irarrazabal & Lin Ma & Juan Carlos Parra-Alvarez, 2023. "Optimal asset allocation for commodity sovereign wealth funds," Quantitative Finance, Taylor & Francis Journals, vol. 23(3), pages 471-495, March.
    5. Robert Elliott & Carlton-James Osakwe, 2006. "Option Pricing for Pure Jump Processes with Markov Switching Compensators," Finance and Stochastics, Springer, vol. 10(2), pages 250-275, April.
    6. Thomas J. Sargent & Neng Wang & Jinqiang Yang, 2021. "Stochastic Earnings Growth and Equilibrium Wealth Distributions," NBER Working Papers 28473, National Bureau of Economic Research, Inc.
    7. Robert J. Elliott & Carlton-James U. Osakwe, 2006. "Option Pricing for Pure Jump Processes with Markov Switching Compensators," Finance and Stochastics, Springer, vol. 10(2), pages 250-275, April.
    8. Wang, Neng, 2009. "Optimal consumption and asset allocation with unknown income growth," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 524-534, May.
    9. Wang, Neng, 2006. "Generalizing the permanent-income hypothesis: Revisiting Friedman's conjecture on consumption," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 737-752, May.
    10. Misha Beek & Michel Mandjes & Peter Spreij & Erik Winands, 2020. "Regime switching affine processes with applications to finance," Finance and Stochastics, Springer, vol. 24(2), pages 309-333, April.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Kevin Kurt & Rudiger Frey, 2021. "Markov-Modulated Affine Processes," Papers 2106.16240, arXiv.org, revised Aug 2022.
    2. Kurt, Kevin & Frey, Rüdiger, 2022. "Markov-modulated affine processes," Stochastic Processes and their Applications, Elsevier, vol. 153(C), pages 391-422.
    3. Lian, Yu-Min & Chen, Jun-Home, 2021. "Pricing virtual currency-linked derivatives with time-inhomogeneity," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 424-439.
    4. Jun Yu, 2014. "Optimal Asset-Liability Management for an Insurer Under Markov Regime Switching Jump-Diffusion Market," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 21(4), pages 317-330, November.
    5. Christensen, Peter Ove & Larsen, Kasper & Munk, Claus, 2012. "Equilibrium in securities markets with heterogeneous investors and unspanned income risk," Journal of Economic Theory, Elsevier, vol. 147(3), pages 1035-1063.
    6. Christensen, Bent Jesper & Parra-Alvarez, Juan Carlos & Serrano, Rafael, 2021. "Optimal control of investment, premium and deductible for a non-life insurance company," Insurance: Mathematics and Economics, Elsevier, vol. 101(PB), pages 384-405.
    7. Luo, Yulei & Nie, Jun & Wang, Haijun, 2022. "Ignorance, pervasive uncertainty, and household finance," Journal of Economic Theory, Elsevier, vol. 199(C).
    8. Alessandro Ramponi, 2011. "Mixture Dynamics and Regime Switching Diffusions with Application to Option Pricing," Methodology and Computing in Applied Probability, Springer, vol. 13(2), pages 349-368, June.
    9. Mariacristina De Nardi & Giulio Fella, 2017. "Saving and Wealth Inequality," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 280-300, October.
    10. Fischer, Thomas, 2019. "Determinants of Wealth Inequality and Mobility in General Equilibrium," Working Papers 2019:22, Lund University, Department of Economics.
    11. David Liu, 2020. "Markov modulated jump-diffusions for currency options when regime switching risk is priced," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 6(04), pages 1-26, February.
    12. Lian, Yu-Min & Liao, Szu-Lang & Chen, Jun-Home, 2015. "State-dependent jump risks for American gold futures option pricing," The North American Journal of Economics and Finance, Elsevier, vol. 33(C), pages 115-133.
    13. Xiaoyu Deng & Jing Tian & Rong Chen, 2019. "Effect of Social Security System on Consumption through Income and Uncertainty: Evidence from China," Sustainability, MDPI, vol. 11(7), pages 1-16, March.
    14. Liu, Guo & Jin, Zhuo & Li, Shuanming, 2021. "Household Lifetime Strategies under a Self-Contagious Market," European Journal of Operational Research, Elsevier, vol. 288(3), pages 935-952.
    15. Suhan Altay & Katia Colaneri & Zehra Eksi, 2017. "Portfolio optimization for a large investor controlling market sentiment under partial information," Papers 1706.03567, arXiv.org.
    16. Xiangdong Liu & Zanbin Zhang, 2023. "Pricing European Vulnerable Options with Jumps and Stochastic Default Obstacles Barrier under Regime Switching," Mathematics, MDPI, vol. 11(19), pages 1-18, October.
    17. Romuald Hervé Momeya & Manuel Morales, 2016. "On the Price of Risk of the Underlying Markov Chain in a Regime-Switching Exponential Lévy Model," Methodology and Computing in Applied Probability, Springer, vol. 18(1), pages 107-135, March.
    18. Lijun Bo & Yongjin Wang & Xuewei Yang, 2014. "On the Default Probability in a Regime-Switching Regulated Market," Methodology and Computing in Applied Probability, Springer, vol. 16(1), pages 101-113, March.
    19. Misha Beek & Michel Mandjes & Peter Spreij & Erik Winands, 2020. "Regime switching affine processes with applications to finance," Finance and Stochastics, Springer, vol. 24(2), pages 309-333, April.
    20. Bo, Lijun & Wang, Yongjin & Yang, Xuewei, 2010. "Markov-modulated jump-diffusions for currency option pricing," Insurance: Mathematics and Economics, Elsevier, vol. 46(3), pages 461-469, June.

    More about this item

    Keywords

    Optimal search; Stochastic income; Affine processes; Regime-switching;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finlet:v:58:y:2023:i:pa:s154461232300702x. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/frl .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.