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Recursive utility using the stochastic maximum principle

Aase, Knut K.
Working paper
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0314.pdf (468.1Kb)
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http://hdl.handle.net/11250/194959
Utgivelsesdato
2014-02
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  • Discussion papers (FOR) [514]
Sammendrag
Motivated by the problems of the conventional model in rationalizing market data, we derive the equilibrium interest rate and risk

premiums using recursive utility in a continuous time model. We

consider the version of recursive utility which gives the most unambiguous separation of risk preference from time substitution, and use

the stochastic maximum principle to analyze the model. This method

uses forward/backward stochastic differential equations. With existence granted, the market portfolio is determined in terms of future

utility and aggregate consumption in equilibrium. The equilibrium

real interest rate is also derived, and the the model is shown to be consistent with reasonable values of the parameters of the utility function

when calibrated to market data, under various assumptions.s that the state prices depend on past consumption. We use the stochastic maximum principle

and forward/backward stochastic di erential equations to derive two

ordinally equivalent versions. The resulting equilibrium is consistent

with reasonable values of the parameters of the utility functions when

calibrated to market data, under various assumptions.
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