Dual Formulation of the Optimal Consumption Problem with Multiplicative Habit Formation

This paper provides a dual formulation of the optimal consumption problem with internal multiplicative habit formation. In this problem, the agent derives utility from the ratio of consumption to the internal habit component. Due to this multiplicative specification of the habit model, the optimal consumption problem is not strictly concave and incorporates irremovable path-dependency. As a consequence, standard Lagrangian techniques fail to supply a candidate for the corresponding dual formulation. Using Fenchel’s Duality Theorem, we manage to identify a candidate formulation and prove that it satisfies strong duality. On the basis of this strong duality result, we develop an evaluation mechanism to measure the accuracy of analytical or numerical approximations to the optimal solutions.

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