Abstract: We analyze consumption and asset pricing with recursive
preferences given by KrepsPorteus stochastic differential
utility (KP SDU). We show that utility depends on two state
variables: current consumption and a second variable (related
to the wealthconsumption ratio) that captures all
information about future opportunities. This representation of
utility reduces the internal consistency condition for KP
SDU to a restriction on the second variable in terms of the
dynamics of a forcing process (consumption, the stateprice
deflator, or the return on the market portfolio). Solving the
model for (i) optimal consumption, (ii) the optimal portfolio,
and (iii) asset prices in general equilibrium amounts to
finding the process for the second variable that satisfies
this restriction. We show that the wealthconsumption ratio
is the value of an annuity when the numeraire is changed from
units of the consumption good to units of the consumption
process, and we characterize certain features of the solution
in a nonMarkovian setting. In a Markovian setting, we provide
a solution method that is quite general and can be used to
produce fast, accurate numerical solutions that converge to
the Taylor expansion.
Keywords: Recursive preferences, stochastic differential utility, general equilibrium, optimal consumption, optimal portfolio, equity premium, term structure of interest rates, asset pricing
Full paper (805 KB PDF)
 Full paper (1421 KB Postscript)
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