Recursive preferences characterize the trade-offs between current and future consumption by summarizing the future with a single index, the certainty equivalent of next period’s utility. Recursive utility functions are built from two components. A risk aggregator encodes trade-offs across the outcomes of a static gamble and, hence, defines the certainty equivalent of future utility. A time aggregator encodes trade-offs between current consumption and the certainty equivalent of future utility. We suggest functional forms for time and risk aggregators with desirable properties for applications in economics and finance, such as the standard intertemporal consumption/portfolio problem, which we solve using dynamic programming.
KeywordsBellman equation Certainty equivalent Disappointment aversion Dynamic optimization Elasticity of intertemporal substitution Expected utility Impatience Infinite horizons Preferences Rational expectations Recursive preferences Risk aggregator Risk aversion Stochastic dynamic models Time aggregator Time preference Utility functions Weighted utility
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