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Dynamic Investment, Risk Aversion, and Foresight Sensitivity

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  • Tesfatsion, Leigh S.

Abstract

Since optimal investment strategies generally cannot be obtained in closed form when consumers exhibit non-constant risk aversion, many dynamic investment studies have focused on the constant risk aversion case. This study considers a general class of dynamic investment models in which agents are not restricted to have constant risk aversion. Existence, monotonicity, concavity, differentiability, and absolute risk aversion properties are established analytically for the optimal feedback investment strategies and dynamic progamming value functions. A bound is also obtained on the loss in expected utility resulting from the use of limited foresight horizons. Finally, results are reported for computer experiments conducted to explore the sensitivity of expected utility outcomes to changes in the length of the foresight horizon. For example, the results indicate the optimality of a rolling 2-period foresight horizon for a particular class of exponential utility functions exhibiting decreasing risk aversion. Annotated pointers to related work can be accessed here: http://www2.econ.iastate.edu/tesfatsi/dehome.htm

Suggested Citation

  • Tesfatsion, Leigh S., 1981. "Dynamic Investment, Risk Aversion, and Foresight Sensitivity," Staff General Research Papers Archive 11217, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genres:11217
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    Cited by:

    1. Hildreth, Clifford, 1983. "Qualitative Analysis Of Production And Hedging," Staff Papers 13765, University of Minnesota, Department of Applied Economics.
    2. Suresh Chand & Vernon Ning Hsu & Suresh Sethi, 2002. "Forecast, Solution, and Rolling Horizons in Operations Management Problems: A Classified Bibliography," Manufacturing & Service Operations Management, INFORMS, vol. 4(1), pages 25-43, September.

    More about this item

    Keywords

    Bounded rationality; dynamic investment; non-constant risk aversion; dynamic programming;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D9 - Microeconomics - - Micro-Based Behavioral Economics

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