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Survival and long-run dynamics with heterogeneous beliefs under recursive preferences

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  • Jaroslav Borovicka

Abstract

I 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.

Suggested Citation

  • Jaroslav Borovicka, 2011. "Survival and long-run dynamics with heterogeneous beliefs under recursive preferences," Working Paper Series WP-2011-06, Federal Reserve Bank of Chicago.
  • Handle: RePEc:fip:fedhwp:wp-2011-06
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    References listed on IDEAS

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    1. Elyès Jouini & Clotilde Napp, 2007. "Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1149-1174.
    2. Harjoat S. Bhamra & Raman Uppal, 2014. "Asset Prices with Heterogeneity in Preferences and Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 519-580.
    3. Hui Chen & Scott Joslin & Ngoc-Khanh Tran, 2012. "Rare Disasters and Risk Sharing with Heterogeneous Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 25(7), pages 2189-2224.
    4. Kogan, Leonid & Ross, Stephen A. & Wang, Jiang & Westerfield, Mark M., 2017. "Market selection," Journal of Economic Theory, Elsevier, vol. 168(C), pages 209-236.
    5. Philippe Weil, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 29-42.
    6. Hongjun Yan, 2008. "Natural Selection in Financial Markets: Does It Work?," Management Science, INFORMS, vol. 54(11), pages 1935-1950, November.
    7. Epstein, Larry G. & Miao, Jianjun, 2003. "A two-person dynamic equilibrium under ambiguity," Journal of Economic Dynamics and Control, Elsevier, vol. 27(7), pages 1253-1288, May.
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    Cited by:

    1. Timothy Cogley & Thomas J. Sargent & Viktor Tsyrennikov, 2014. "Wealth Dynamics in a Bond Economy with Heterogeneous Beliefs," Economic Journal, Royal Economic Society, vol. 124(575), pages 1-30, March.

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    Keywords

    Consumption (Economics);

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