A Note on Robustness in Merton's Model of Intertemporal Consumption and Portfolio Choice
Journal
Journal of Economic Dynamics and Control
ISSN
0165-1889
ISSN-Digital
1879-1743
Type
journal article
Date Issued
2002-03-01
Author(s)
Trojani, Fabio
;
Vanini, Paolo
Abstract
The paper presents a robust version of a simple two-assets Merton (1969, Review of Economics and Statistics 51, 247-57) model where the optimal choices and the implied shadow market prices of risk for a representative robust decision maker (RDM) can be easily described. With the exception of the log-utility case, precautionary behaviour is induced in the optimal consumption-investment rules through a substitution of investment in risky assets with both current consumption and riskless saving. For the log-utility case, precautionary behaviour arises only through a substitution between risky and riskless assets. On the financial side, the decomposition of the market price of risk in a standard consumption based component and a further price for model uncertainty risk (which is positively related to the robustness parameter) is independent of the underlying risk aversion parameter.
Language
English
Keywords
Merton's model
Knightian uncertainty
Model contamination
Model misspecification
Robust decision-making
HSG Classification
not classified
Refereed
No
Publisher
North-Holland Publ. Co
Publisher place
Amsterdam
Volume
26
Number
3
Start page
423
End page
435
Pages
13
Subject(s)
Division(s)
Eprints ID
12648