DP4701 A Portfolio Choice Model with Utility from Anticipation of Future Consumption and Stock Markets' Mean Reversion

Author(s): Shmuel Kandel, Arik Kuznitz
Publication Date: October 2004
Keyword(s): consumption, habit-formation, mean reversion, portfolio
JEL(s):
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4701

This Paper studies a consumption and portfolio choice problem of a long-lived investor who derives pleasure not only from current consumption, but also from contemplation of future consumption. These preferences are formalized by Kuznitz (2003a, 2003b, 2003c), in a model where all effects of future consumption on current well being are assumed to enter through a single variable ? that is, the ?stock of future consumption? ? analogously to habit-formation models. The main implications of the model concern the incentives for savings, and the fundamental sources of risk in financial markets. In this Paper it is shown that, when the stock market exhibits mean reversion, deriving utility from anticipation of future consumption has a tremendous effect on portfolio choice. In particular, mean allocation to stocks is much lower under the proposed preferences relative to the standard preferences, especially for high-risk averse investors.