A note on robustness in Merton's model of intertemporal consumption

  • Trojani, Fabio Istituto di finanza (IFin), Facoltà di scienze economiche, Università della Svizzera italiana, Svizzera
  • Vanini, Paolo ECOFIN Research and Consulting AG, Zürich, Svizzera

15 p.

English The paper presents a robust version of a simple two-assets Merton's (1969) 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 exeption 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.
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  • RERO DOC 9078
  • ARK ark:/12658/srd1317900
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