Consumption Ratcheting and Loss Aversion

Abstract

We investigate the dynamic consumption and portfolio selection problem of an agent who has an intertemporal preference with loss and risk aversion, as proposed by Choi et al. (2019a). We disentangle the effects of loss aversion from those of risk aversion on risk taking. We show by simulation that the model can match well the moments of US aggregate consumption data. The model can be applied to practical asset management designed to produce stable cash flows. We also provide extensions of the model including the durable goods and multiple goods.