Dynamic asset allocation and consumption with the indirect utility function

Abstract

Articles about asset allocation rely on the direct utility as a primitive to model the risk appetite of investors and to derive optimal asset allocation and consumption. In a simple setting, we show that the same problem can be solved where the indirect utility function is used as a primitive. Our approach offers various advantages. The indirect utility function measures the satisfaction at optimum and perfectly describes the risk appetite of investors. It is a function of wealth whereas the direct utility function depends on consumption.