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OPTIMAL CONSUMPTION WHEN INCOME FOLLOWS A MARKOV PROCESS
Author(s) -
Hey John D.
Publication year - 1984
Publication title -
bulletin of economic research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.227
H-Index - 29
eISSN - 1467-8586
pISSN - 0307-3378
DOI - 10.1111/j.1467-8586.1984.tb00529.x
Subject(s) - economics , consumption (sociology) , econometrics , autoregressive model , consumption function , order (exchange) , markov chain , microeconomics , random walk , constant (computer programming) , marginal utility , risk aversion (psychology) , permanent income hypothesis , econometric model , mathematical economics , mathematics , expected utility hypothesis , production (economics) , macroeconomics , statistics , computer science , social science , finance , sociology , programming language , market liquidity
In econometric investigations of consumption, the econometrician may either estimate the structural relationship or investigate the implication (revealed by Hall) that the marginal utility of consumption follows a random walk. Researchers have been inhibited from following the former route by the lack of an explicit theoretical relationship. This paper removes this inhibition by deriving the optimal consumption strategy of an individual with constant absolute risk‐aversion, whose income is generated by an nth order normal autoregressive process. We show that the implied structural relationship is linear in wealth and lagged income terms (up to the nth order). This facilitates informative and efficient econometric exploration of the consumption function.