Asset Pricing Models with Preference Shocks: Existence and Uniqueness

Abstract

This paper studies existence and uniqueness of recursive utility in asset pricing models with preference shocks. We provide conditions that clarify existence and uniqueness for a wide range of models, including exact necessary and sufficient conditions for standard formulations. The conditions isolate the roles of preference parameters, as well as the different risks that drive the consumption and preference shock processes. We show that existence crucially depends on the intertemporal elasticity of substitution of the investor. Even slight changes in the IES can turn a model with a well-defined solution into one where no solution exists.

Keywords: Asset pricing, recursive preferences, preference shocks, Epstein-Zin preferences, long-run risk

JEL Classification: D81, G11