Elements of Economics of Uncertainty and Time with Recursive Utility

Abstract

We address how recursive utility affects important results in the theory of economics of uncertainty and time, as compared to the standard model, where the focus is on dynamic models in discrete time. Several puzzles associated with the standard theory are less puzzling with recursive utility, even if this type of preference representation seems close to the standard one at first sight. An inconsistency with the axioms behind the standard, separable and additive expected utility representation is pointed out and extended to also be relevant for recursive utility. The basic difference from the standard model is that recursive utility allows a form of separation of consumption substitution from risk aversion. This also means that the timing of resolution of uncertainty matters. In dynamic models, however, this turns out to be a rather crucial step.

The Optimal Spending Rate versus the Expected Real Return of a Sovereign Wealth Fund

“…Unlike expected utility theory in a timeless situation, i.e., when consumption only takes place at the end, in a temporal setting where the agent consumes in every period, derived preferences have been claimed not to satisfy the substitution axiom (e.g., Mossin (1969); Kreps (1988)). In Aase (2021) this claim is demonstrated to be incorrect.…”

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