Optimal risk sharing with translation invariant recursive utility in continuous time

Abstract

We consider optimal risk sharing where agents have preferences represented by translation invariant recursive utility. The dynamics in continuous time is driven by diffusion processes. The model has some appealing features compared to the scale invariant version. First, the model allows for heterogenous agents, where optimal risk sharing can be addressed. Second, a new endogenous variable allows for a variety of results, not possible in the standard model. The model allows for a new look at the mutuality principle. We also endow the model with a stock market and derive a consumption based capital asset pricing model.