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Intertemporal preference with loss aversion: Consumption and risk-attitude

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  • Choi, Kyoung Jin
  • Jeon, Junkee
  • Koo, Hyeng Keun

Abstract

We study the consumption and portfolio selection problem of economic agents who face consumption irreversibility: there is disutility from changing consumption levels. The derived preference exhibits loss aversion toward a consumption gamble with the previous consumption level being the reference point. The optimization problem involves a non-monotonic and non-concave utility function. We derive a closed-form solution by combining a duality method and the super-contact principle. We show that the consumption policy involves an inaction interval for the consumption-permanent income ratio, which are consistent with various empirical regularities about consumption. The effective risk aversion derived from agents' optimal portfolio choice exhibits an inverted U-shape in the inaction interval.

Suggested Citation

  • Choi, Kyoung Jin & Jeon, Junkee & Koo, Hyeng Keun, 2022. "Intertemporal preference with loss aversion: Consumption and risk-attitude," Journal of Economic Theory, Elsevier, vol. 200(C).
    • Handle: RePEc:eee:jetheo:v:200:y:2022:i:c:s0022053121001976
    DOI: 10.1016/j.jet.2021.105380
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    More about this item

    Keywords

    Consumption irreversibility; Intertemporal loss aversion; Excess sensitivity and smoothness; Asymmetric sensitivities; Consumption heterogeneity; U-shaped risky share;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    Statistics

    Access and download statistics

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