Optimal consumption and investment under irrational beliefs

Lei Sun; Lihong Zhang

doi:10.3934/jimo.2011.7.139

Article Contents

2011, Volume 7, Issue 1: 139-156. Doi: 10.3934/jimo.2011.7.139

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Optimal consumption and investment under irrational beliefs

Lei Sun^1, and
Lihong Zhang^2,

1.
School of Business and Management, Hong Kong University of Science and Technology, Hong Kong
2.
School of Economics and Management, Tsinghua University, Beijing

Received: March 2010

Revised: October 2010

Published: January 2011

Abstract / Introduction Related Papers Cited by

Abstract

In this paper, we study how irrationality affects the investor's consumption and investment decisions. We build a continuous-time financial model, where an irrational investor determines his consumption and investment according to an exogenous price process. The main results are as follows. First, compared with a rational investor, an optimistic irrational investor tends to consume more, while a pessimistic irrational investor tends to consume less. Second, the more irrational the investor, the more volatile his consumption. Third, the extremely irrational investor can get more ex ante expected utility than his rational counterpart, no matter he is optimistic or pessimistic.

Keywords:

Mathematics Subject Classification: Primary: 91B28; Secondary: 91B08, 91B16, 91B70.

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