Nonrecursive separation of risk and time preferences
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- Nonrecursive Separation of Risk and Time Preferences
Submitted manuscript, 525 KB, PDF document
Recursive utility disentangles preferences with respect to time and risk by recursively building up a value function of local increments. This involves certainty equivalents of indirect utility. Instead we disentangle preferences with respect to time and risk by building up a value function as a non-linear aggregation of certainty equivalents of direct utility of consumption. This entails time-consistency issues which are dealt with by looking for an equilibrium control and an equilibrium value function rather than a classical optimal control and a classical optimal value function. We characterize the solution in a general diffusive incomplete market model and find that, in certain special cases of utmost interest, the characterization coincides with what would arise from a recursive utility approach. But also importantly, in other cases, it does not: The two approaches are fundamentally different but match, exclusively but importantly, in the mathematically special case of homogeneity of the value function.
Original language | English |
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Journal | Journal of Mathematical Economics |
Volume | 90 |
Pages (from-to) | 95-108 |
ISSN | 0304-4068 |
DOIs | |
Publication status | Published - 2020 |
- Certainty equivalents, Equilibrium strategies, Generalized Hamilton–Jacobi–Bellman equation, Recursive utility, Time-consistency, Time-global preferences
Research areas
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