Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

Abstract: We address how recursive utility affects important results in the theory of economics of uncertainty and time, as compared to the standard model, where the focus is on dynamic models in discrete time. Several puzzles associated with the standard theory are less puzzling with recursive utility, even if this type of preference representation seems close to the standard one at first sight. An inconsistency with the axioms behind the standard, separable and additive expected utility representation is pointed out and extended to also be relevant for recursive utility. The basic difference from the standard model is that recursive utility allows a form of separation of consumption substitution from risk aversion. This also means that the timing of resolution of uncertainty matters. In dynamic models, however, this turns out to be a rather crucial step.

Keywords: Recursive utility; axioms; scale invariance; utility gradients; the equity premium puzzle; precautionary savings

JEL-codes: D51; D53; D90; E21; G10; G12

38 pages, October 30, 2020

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