An optimal consumption-investment model with constraint on consumption

Zuoquan Xu, Fahuai Yi

Research output: Journal article publicationJournal articleAcademic researchpeer-review

7 Citations (Scopus)

Abstract

A continuous-time consumption-investment model with constraint is considered for a small investor whose decisions are the consumption rate and the allocation of wealth to a risk-free and a risky asset with logarithmic Brow- nian motion uctuations. The consumption rate is subject to an upper bound constraint which linearly depends on the investor's wealth and bankruptcy is prohibited. The investor's objective is to maximize the total expected dis- counted utility of consumption over an infinite trading horizon. It is shown that the value function is (second order) smooth everywhere but a unique (known) possibly exception point and the optimal consumption-investment strategy is provided in a closed feedback form of wealth. According to this model, an investor should take the similar investment strategy as in Merton's model re- gardless his financial situation. By contrast, the optimal consumption strategy does depend on the investor's financial situation: he should use a similar con- sumption strategy as in Merton's model when he is in a bad situation, and consume as much as possible when he is in a good situation.
Original languageEnglish
Pages (from-to)517-534
Number of pages18
JournalMathematical Control and Related Fields
Volume6
Issue number3
DOIs
Publication statusPublished - 1 Sep 2016

Keywords

  • Constrained consumption
  • Constrained viscosity solu-tion
  • Free boundary problem
  • Optimal consumption-investment model
  • Stochastic control in finance

ASJC Scopus subject areas

  • Control and Optimization
  • Applied Mathematics

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