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Restricted dynamic consistency

Author

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  • Lorenzo Stanca

    (Collegio Carlo Alberto and University of Turin)

Abstract

Dynamic consistency is a key behavioral property in dynamic economic models, making it possible to use tractable dynamic programming techniques. However, when combined with the separation of time and risk preferences, it can lead to unrealistic predictions that contradict empirical evidence. This paper demonstrates that dynamic consistency can be relaxed to hold over a much smaller domain of consumption programs while maintaining sufficient richness for practical applications and allowing the separation of risk aversion from intertemporal substitution. As an application, I introduce a new model of dynamic preferences, the Epstein–Zin–Selden–Stux preferences. These preferences are recursive only within a restricted domain. Recent experimental results by Meissner and Pfeiffer (J Econ Theory 200:105379, 2022), which Epstein–Zin preferences cannot rationalize, find a natural explanation through this new model. Finally, I consider an application of this new model to a consumption-investment problem.

Suggested Citation

  • Lorenzo Stanca, 2025. "Restricted dynamic consistency," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 80(4), pages 1203-1231, December.
    • Handle: RePEc:spr:joecth:v:80:y:2025:i:4:d:10.1007_s00199-025-01655-3
    DOI: 10.1007/s00199-025-01655-3
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    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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