Abstract
To effectively cope with an unexpected, large, and negative income shock, I propose a life-cycle model for income risk management. I analyze the intertemporal consumption-investment problem in an incomplete market. I suggest a hybrid of the martingale approach and the dynamic programming approach for solving the problem and deriving closed-form solutions. The model has strong empirical implications on anomalies in finance. Finally, I provide a general equilibrium analysis by generalizing the Arrow-Debreu price with income risk premium.
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