# Stochastic maximum principle with Lagrange multipliers and optimal consumption with L\'evy wage

## TL;DR

This paper develops a stochastic maximum principle with Lagrange multipliers for jump diffusions and applies it to an optimal consumption problem involving Le9vy income processes and stochastic inflation, providing explicit solutions for CRRA utility.

## Contribution

It introduces a novel stochastic maximum principle with Lagrange multipliers for jump diffusions and applies it to a constrained consumption optimization with Le9vy income.

## Key findings

- Derived explicit optimal consumption expressions for CRRA utility.
- Provided economic interpretation of the adjoint processes.
- Analyzed effects of inflation and wage risk on consumption choices.

## Abstract

We show how a stochastic version of the Lagrange multiplier method can be combined with the stochastic maximum principle for jump diffusions to solve certain constrained stochastic optimal control problems. Two different terminal constraints are considered; one constraint holds in expectation and the other almost surely. As an application of this method, we study the effects of inflation- and wage risk on optimal consumption. To do this, we consider the optimal consumption problem for a budget constrained agent with a L\'evy income process and stochastic inflation. The agent must choose a consumption path such that his wealth process satisfies the terminal constraint. We find expressions for the optimal consumption of the agent in the case of CRRA utility, and give an economic interpretation of the adjoint processes.