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Habit Formation from Correlation Aversion

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  • Kenneth C. Lichtendahl

    (Darden School of Business, University of Virginia, Charlottesville, Virginia 22903)

  • Raul O. Chao

    (Darden School of Business, University of Virginia, Charlottesville, Virginia 22903)

  • Samuel E. Bodily

    (Darden School of Business, University of Virginia, Charlottesville, Virginia 22903)

Abstract

Making plans about how much to consume and how much to invest in risky assets over an uncertain lifetime is a fundamental economic challenge. The leading models of this planning problem use either additive or habit-forming preferences. For the most part, these models assume an individual is either correlation neutral or correlation seeking in consumption, respectively. In this paper, we introduce two habit-forming, correlation-averse preference models. With these preferences, we find closed-form solutions to the classic consumption and portfolio planning problem. Our solutions recommend that a correlation-averse decision maker follow a habit in their consumption plans. While such habits traditionally have been associated with correlation-seeking preferences, our model leads to consumption habits from correlation-averse preferences.

Suggested Citation

  • Kenneth C. Lichtendahl & Raul O. Chao & Samuel E. Bodily, 2012. "Habit Formation from Correlation Aversion," Operations Research, INFORMS, vol. 60(3), pages 625-637, June.
    • Handle: RePEc:inm:oropre:v:60:y:2012:i:3:p:625-637
    DOI: 10.1287/opre.1120.1046
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    References listed on IDEAS

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    Cited by:

    1. Ying He & James S. Dyer & John C. Butler, 2013. "On the Axiomatization of the Satiation and Habit Formation Utility Models," Operations Research, INFORMS, vol. 61(6), pages 1399-1410, December.
    2. Kenneth C. Lichtendahl & Samuel E. Bodily, 2012. "Multiplicative Utilities for Health and Consumption," Decision Analysis, INFORMS, vol. 9(4), pages 314-328, December.

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