Consumption paths under prospect utility in an optimal growth model

This paper studies the Cass–Koopmans–Ramsey model of optimal economic growth in the presence of loss aversion and habit formation. The representative agent's preferences for consumption can be gradually varied between the standard constant intertemporal elasticity of substitution (CIES) case an...

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Bibliographic Details
Published in:Journal of economic dynamics & control 2011-03, Vol.35 (3), p.273-281
Main Authors: Foellmi, Reto, Rosenblatt-Wisch, Rina, Schenk-Hoppé, Klaus Reiner
Format: Article
Language:English
Subjects:
Agency theory
Consumption
Consumption theory
Economic growth
Elasticity
Elasticity of substitution
Growth models
Growth theory
Loss aversion
Optimal consumption
Prospect theory
Ramsey growth model
Ramsey growth model Prospect theory Loss aversion Optimal consumption
Studies
Utility functions
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Summary:This paper studies the Cass–Koopmans–Ramsey model of optimal economic growth in the presence of loss aversion and habit formation. The representative agent's preferences for consumption can be gradually varied between the standard constant intertemporal elasticity of substitution (CIES) case and Kahneman and Tversky's prospect utility. We find that the transitional dynamics of optimal consumption paths differ distinctly from the standard model, in particular consumption smoothing is more pronounced. We also show that prospect utility can cause the economy to remain in a steady state with low consumption and low capital.
ISSN:0165-1889
1879-1743
DOI:10.1016/j.jedc.2010.09.002