Optimal Recursive Utility Maximization with Debt-to-Income Limits

We study a continuous-time optimal consumption and portfolio selection problem when an economic agent with recursive utility has stochastic income and debt-to-income borrowing limits. The optimal portfolio depends on the elasticity of intertemporal substitution (EIS) due to the borrowing constraints even if the investment opportunity is constant. The paper has novel implications for the optimal policies and the marginal propensity to consume (MPC) under recursive preference. The model provides a testable implication that stock market participants have higher MPCs than non-participants. We also make a technical contribution by developing a new transform to handle the problems with recursive utility.