BANKRUPTCY AND EXPECTED UTILITY MAXIMIZATION

This paper introduces a utility formulation to the well-known gambler's ruin problem. An agent who maximizes lifetime expected utility has to trade off short-term utility against longer-term survival prospects. The optimal tradeoff is established by way of characterizing the agent's value and optimal policy functions. Further, the scope of expected utility maximization is examined by contrasting the bankruptcy probabilities of an agent employing such a criterion with those of an agent who is more directly interested in survival. Economic applications of the theory are also discussed.