Dynamic Resource Management: Intertemporal Substitution and Risk Aversion

Abstract

We consider resource management with recursive preferences. These generalize expected utility while eliminating some well‐known difficulties. Monotonicity and convergence properties of optimal decision rules are established using lattice programming methods. Empirical applications are rangeland and groundwater management. Decreasing the intertemporal elasticity of substitution implies greater (lower) resource usage with limited (abundant) stocks. This moderates stock evolution and stabilizes consumption. Increasing risk aversion implies the same or reduced usage over the state space. Intertemporal substitution has a substantial effect on the optimal decision rule and a moderate effect on the limiting distribution, while risk aversion has a very small effect.

Keywords: dynamic programming, intertemporal substitution, recursive utility, risk aversion, Q210, Q240, Q250