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Recursive utility with dependence on past consumption; the continuous-time model

  • Aase, Knut K.

    ()

    (Dept. of Business and Management Science, Norwegian School of Economics)

Motivated by the problems of the conventional model in rationalizing market data, we derive the equilibrium interest rate and risk premiums using recursive utility in a continuous time model. We relax one restriction on dynamic utility, in that we do not assume irrelevance of past consumption for current marginal utility. One motive for this extension is added realism, another is that the state prices depend on past consumption. We use the stochastic maximum principle and forward/backward stochastic differential equations to derive two ordinally equivalent versions. The resulting equilibrium is consistent with reasonable values of the parameters of the utility functions when calibrated to market data, under various assumptions.

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File URL: http://hdl.handle.net/11250/194960
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Paper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2014/3.

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Length: 42 pages
Date of creation: 20 Feb 2014
Date of revision:
Handle: RePEc:hhs:nhhfms:2014_003
Contact details of provider: Postal: NHH, Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Phone: +47 55 95 92 93
Fax: +47 55 95 96 50
Web page: http://www.nhh.no/en/research-faculty/department-of-business-and-management-science.aspx
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