Optimal investor life cycle decisions with time-inconsistent preferences

Abstract

We examine the lifetime decisions of an investor with time-inconsistent preferences, obtaining optimal time-consistent strategies for investment, consumption, and life insurance premiums explicitly under a stationary Markov perfect equilibrium framework. We find that the investor increases consumption to seek immediate gratification, and simultaneously increases life insurance purchasing to fulfill a legacy need. However, at a later stage in the life cycle, the investor confronts slower wealth accumulation and reduces consumption and life insurance purchasing accordingly. We also investigate the effects of naivete, degree of time inconsistency, risk preferences, legacy weight, insurance cost, death duty, and labor income on the investor's decision making. Our study reveals the balance of consumption, bequest, and terminal wealth motives in life cycle decisions featuring microfounded bequest utility and stochastic labor income.