TY - JOUR
T1 - Personal finance and life insurance under separation of risk aversion and elasticity of substitution
AU - Jensen, Ninna Reitzel
AU - Steffensen, Mogens
PY - 2015/5/1
Y1 - 2015/5/1
N2 - In a classical Black–Scholes market, we establish a connection between two seemingly different approaches to continuous-time utility optimization. We study the optimal consumption, investment, and life insurance decision of an investor with power utility and an uncertain lifetime. To separate risk aversion from elasticity of inter-temporal substitution, we introduce certainty equivalents. We propose a time-inconsistent global optimization problem, and we present a verification theorem for an equilibrium control. In the special case without mortality risk, we discover that our optimization approach is equivalent to recursive utility optimization with Epstein–Zin preferences in the sense that the two approaches lead to the same result. We find this interesting since our optimization problem has an intuitive interpretation as a global maximization of certainty equivalents and since recursive utility, in contrast to our approach, gives rise to severe differentiability problems. Also, our optimization approach can there be seen as a generalization of recursive utility optimization with Epstein–Zin preferences to include mortality risk and life insurance.
AB - In a classical Black–Scholes market, we establish a connection between two seemingly different approaches to continuous-time utility optimization. We study the optimal consumption, investment, and life insurance decision of an investor with power utility and an uncertain lifetime. To separate risk aversion from elasticity of inter-temporal substitution, we introduce certainty equivalents. We propose a time-inconsistent global optimization problem, and we present a verification theorem for an equilibrium control. In the special case without mortality risk, we discover that our optimization approach is equivalent to recursive utility optimization with Epstein–Zin preferences in the sense that the two approaches lead to the same result. We find this interesting since our optimization problem has an intuitive interpretation as a global maximization of certainty equivalents and since recursive utility, in contrast to our approach, gives rise to severe differentiability problems. Also, our optimization approach can there be seen as a generalization of recursive utility optimization with Epstein–Zin preferences to include mortality risk and life insurance.
U2 - 10.1016/j.insmatheco.2015.02.006
DO - 10.1016/j.insmatheco.2015.02.006
M3 - Journal article
SN - 0167-6687
VL - 62
SP - 28
EP - 41
JO - Insurance: Mathematics and Economics
JF - Insurance: Mathematics and Economics
ER -