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January  2011, 7(1): 139-156. doi: 10.3934/jimo.2011.7.139

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, China
2. 

School of Economics and Management, Tsinghua University, Beijing, China

Received  March 2010 Revised  October 2010 Published  January 2011

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: consumption., optimization, Irrational belief, investment.
Mathematics Subject Classification: Primary: 91B28; Secondary: 91B08, 91B16, 91B7.
Citation: Lei Sun, Lihong Zhang. Optimal consumption and investment under irrational beliefs. Journal of Industrial & Management Optimization, 2011, 7 (1) : 139-156. doi: 10.3934/jimo.2011.7.139
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show all references

References:
[1]

Journal of Political Economy, 58 (1950), 211-221. doi: 10.1086/256940.  Google Scholar

[2]

Journal of Finance, 41 (1986), 529-543. doi: 10.2307/2328481.  Google Scholar

[3]

Journal of Political Economy, 81 (1973), 637-654. doi: 10.1086/260062.  Google Scholar

[4]

Econometrica, 74 (2006), 929-966. doi: 10.1111/j.1468-0262.2006.00691.x.  Google Scholar

[5]

Journal of Business, 64 (1991), 1-19. Google Scholar

[6]

Working paper, Hass School of Business, UC Berkeley, 2007. Google Scholar

[7]

University of Chicago Press, Chicago, 1953. Google Scholar

[8]

Econometrica, 55 (1987), 587-613. doi: 10.2307/1913601.  Google Scholar

[9]

Journal of Economic Theory, 20 (1979), 381-408. doi: 10.1016/0022-0531(79)90043-7.  Google Scholar

[10]

Journal of Financial Economics, 81 (2006), 311-338. doi: 10.1016/j.jfineco.2005.05.006.  Google Scholar

[11]

Springer-Verlag, New York, 1998.  Google Scholar

[12]

Journal of Finance, 61 (2006), 195-229. doi: 10.1111/j.1540-6261.2006.00834.x.  Google Scholar

[13]

Review of Economics and Statistics, 47 (1965), 13-37. doi: 10.2307/1924119.  Google Scholar

[14]

Econometrica, 41 (1973), 867-887. doi: 10.2307/1913811.  Google Scholar

[15]

Journal of Economic Theory, 13 (1976), 341-360. doi: 10.1016/0022-0531(76)90046-6.  Google Scholar

[16]

Econometrica, 68 (2000), 1303-1341. doi: 10.1111/1468-0262.00163.  Google Scholar

[17]

Journal of Finance, 19 (1964), 425-442. doi: 10.2307/2977928.  Google Scholar

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