Linked Recursive Preferences and Optimality

36 Pages Posted: 13 Jan 2016

See all articles by Shlomo Levental

Shlomo Levental

Michigan State University

Sumit Sinha

Michigan State University

Mark D. Schroder

Michigan State University - The Eli Broad Graduate School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: January 2016

Abstract

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: BSDE, recursive preferences, translation‐invariant preferences, team contract, Pareto optimality, behavioral contract theory, optimization

Suggested Citation

Levental, Shlomo and Sinha, Sumit and Schroder, Mark D., Linked Recursive Preferences and Optimality (January 2016). Mathematical Finance, Vol. 26, Issue 1, pp. 86-121, 2016. Available at SSRN: https://ssrn.com/abstract=2714638 or http://dx.doi.org/10.1111/mafi.12047

Shlomo Levental (Contact Author)

Michigan State University ( email )

Agriculture Hall
East Lansing, MI 48824-1122
United States

Sumit Sinha

Michigan State University ( email )

Agriculture Hall
East Lansing, MI 48824-1122
United States

Mark D. Schroder

Michigan State University - The Eli Broad Graduate School of Management ( email )

323 Eppley Center
East Lansing, MI 48824-1121
United States
517-432-0622 (Phone)
517-432-1080 (Fax)

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