Optimal Consumption and Portfolio Rules with Durability and Local Substitution.

Abstract

A model of optimal consumption and portfolio choice that captures the notions of local substitution and irreversible purchases of durable goods is studied. Necessary and sufficient conditions for a consumption and portfolio policy to be optimal are provided. A closed-form solution of the optimal consumption and portfolio policy is given. The optimal consumption policy consists of a possible initial "gulp" of consumption, or a period of no consumption, followed.by a process of accumulated consumption with singular sample paths. The equilibrium risk premium in a representative investor economy with a single physical production technology is computed. Copyright 1993 by The Econometric Society.