Survival and long-run dynamics with heterogeneous beliefs under recursive preferences
AbstractI study the long-run behavior of a two-agent economy where agents differ in their beliefs and are endowed with homothetic recursive preferences of the Duffie-Epstein-Zin type. When preferences are separable, the economy is dominated in the long run by the agent whose beliefs are relatively more precise, a result consistent with the market selection hypothesis. However, recursive preference specifications lead to equilibria in which both agents survive, or to ones where either agent can dominate the economy with a strictly positive probability. In this respect, the market selection hypothesis is not robust to deviations from separability. I derive analytical conditions for the existence of nondegenerate long-run equilibria, and show that these equilibria exist for plausible parameterizations when risk aversion is larger than the inverse of the intertemporal elasticity of substitution, providing a justification for models that combine belief heterogeneity and recursive preferences.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-2011-06.
Date of creation: 2011
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-12-05 (All new papers)
- NEP-CBA-2011-12-05 (Central Banking)
- NEP-DGE-2011-12-05 (Dynamic General Equilibrium)
- NEP-EVO-2011-12-05 (Evolutionary Economics)
- NEP-HPE-2011-12-05 (History & Philosophy of Economics)
- NEP-MIC-2011-12-05 (Microeconomics)
- NEP-UPT-2011-12-05 (Utility Models & Prospect Theory)
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