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Dynamic asset allocation and consumption with the indirect utility function

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  • Chibane, Messaoud
  • Six, Pierre

Abstract

Articles about asset allocation rely on the direct utility as a primitive to model the risk appetite of investors and to derive optimal asset allocation and consumption. In a simple setting, we show that the same problem can be solved where the indirect utility function is used as a primitive. Our approach offers various advantages. The indirect utility function measures the satisfaction at optimum and perfectly describes the risk appetite of investors. It is a function of wealth whereas the direct utility function depends on consumption.

Suggested Citation

  • Chibane, Messaoud & Six, Pierre, 2024. "Dynamic asset allocation and consumption with the indirect utility function," Finance Research Letters, Elsevier, vol. 65(C).
    • Handle: RePEc:eee:finlet:v:65:y:2024:i:c:s1544612324005725
    DOI: 10.1016/j.frl.2024.105542
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    References listed on IDEAS

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    1. Luigi Guiso & Monica Paiella, 2008. "Risk Aversion, Wealth, and Background Risk," Journal of the European Economic Association, MIT Press, vol. 6(6), pages 1109-1150, December.
    2. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
    3. Laurent Bach & Laurent E. Calvet & Paolo Sodini, 2020. "Rich Pickings? Risk, Return, and Skill in Household Wealth," American Economic Review, American Economic Association, vol. 110(9), pages 2703-2747, September.
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