Linked Recursive Preferences and Optimality
Mathematical Finance, Forthcoming
36 Pages Posted: 16 May 2013
Date Written: March 29, 2013
We study a class of optimization problems involving linked recursive preferences in a continuous-time Brownian setting. Such links can arise when preferences depend directly on the level or volatility of wealth, in principal-agent (optimal compensation) problems with moral hazard, and when the impact of social influences on preferences is modeled via utility (and utility diffusion) externalities. We characterize the necessary first-order conditions, which are also sufficient under additional conditions ensuring concavity. We also examine applications to optimal consumption and portfolio choice, and applications to Pareto optimal allocations.
Keywords: recursive preferences, BSDE, portfolio selection, Jones, behavioral contract theory
JEL Classification: C00, C61, D61, D91, G11, M52
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