Optimal consumption and savings with stochastic income and recursive utility
Coauthor(s): Chong Wang, Jinqiang Yang.
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We develop a tractable continuous-time consumption-savings model for a liquidity-constrained agent who faces both permanent and transitory income shocks under incomplete markets. We derive an explicitly-solved consumption function and show that the marginal (certainty equivalent) value of liquidity measures the effects of financial frictions on welfare. We further analytically characterize steady-state target savings and demonstrate that risk aversion and inter-temporal substitution have very different effects on savings and the dispersions of wealth and consumption.
Wang, Chong, Neng Wang, and Jinqiang Yang. "Optimal consumption and savings with stochastic income and recursive utility." Columbia Business School, January 2015.