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arXiv · 2006.07223

Optimal Consumption with Reference to Past Spending Maximum

Shuoqing Deng·Xun Li·Huyen Pham·Xiang Yu
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Abstract

This paper studies the infinite-horizon optimal consumption with a path-dependent reference under exponential utility. The performance is measured by the difference between the nonnegative consumption rate and a fraction of the historical consumption maximum. The consumption running maximum process is chosen as an auxiliary state process, and hence the value function depends on two state variables. The Hamilton-Jacobi-Bellman (HJB) equation can be heuristically expressed in a piecewise manner across different regions to take into account all constraints. By employing the dual transform and smooth-fit principle, some thresholds of the wealth variable are derived such that a classical solution to the HJB equation and the feedback optimal investment and consumption strategies can be obtained in closed form in each region. A complete proof of the verification theorem is provided, and numerical examples are presented to illustrate some financial implications.

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Shuoqing Deng, Xun Li, Huyen Pham, Xiang Yu. 2020-06-12. Optimal Consumption with Reference to Past Spending Maximum. https://arxiv.org/abs/2006.07223

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