Recursive utility in a Markov environment with stochastic growth
Open Access
- 9 July 2012
- journal article
- research article
- Published by Proceedings of the National Academy of Sciences in Proceedings of the National Academy of Sciences
- Vol. 109 (30), 11967-11972
- https://doi.org/10.1073/pnas.1200237109
Abstract
Recursive utility models that feature investor concerns about the intertemporal composition of risk are used extensively in applied research in macroeconomics and asset pricing. These models represent preferences as the solution to a nonlinear forward-looking difference equation with a terminal condition. In this paper we study infinite-horizon specifications of this difference equation in the context of a Markov environment. We establish a connection between the solution to this equation and to an arguably simpler Perron–Frobenius eigenvalue equation of the type that occurs in the study of large deviations for Markov processes. By exploiting this connection, we establish existence and uniqueness results. Moreover, we explore a substantive link between large deviation bounds for tail events for stochastic consumption growth and preferences induced by recursive utility.Keywords
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