Asset Pricing and Consumption-Portfolio Choice with Recursive Utility and Unspanned Risk

Abstract We compare local and global polynomial solution methods for DSGE models with Epstein- Zin-Weil utility. We show that model implications for macroeconomic quantities are relatively invariant to choice of solution method but that a global method can yield substantial improvements for asset prices and welfare costs. The divergence in solution quality is highly dependent on parameters which affect value function sensitivity to TFP volatility, as well as the magnitude of TFP volatility itself. This problem is pronounced for calibrations at the extreme of those accepted in the asset pricing literature and disappears for more traditional macroeconomic parameterizations.

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LIFE INSURANCE AND PENSION CONTRACTS II: THE LIFE CYCLE MODEL WITH RECURSIVE UTILITY

Astin Bulletin ◽

10.1017/asb.2015.20 ◽

2015 ◽

Vol 46 (1) ◽

pp. 71-102 ◽

Cited By ~ 3

Author(s):

Knut K. Aase

Keyword(s):

Life Cycle ◽

Portfolio Choice ◽

Life Insurance ◽

Insurance Industry ◽

Life Time ◽

Recursive Utility ◽

Life Cycle Model ◽

Cycle Model ◽

Pension Insurance ◽

The Relationship

AbstractWe analyze optimal consumption and pension insurance during the life time of a consumer using the life cycle model, when the consumer has recursive utility. The relationship between substitution of consumption and risk aversion is highlighted, and clarified by the introduction of this type of preferences. We illustrate how recursive utility can be used to explain the empirical consumption puzzle for aggregates. This indicates a plausible choice for the parameters of the utility function, relevant for the consumer in the life cycle model. Optimal life insurance is considered, as well as the portfolio choice problem related to optimal exposures in risky securities. A major finding is that it is optimal for the typical insurance buyer to smooth adverse shocks to the financial market, unlike what is implied by the conventional model. This has implications for what type of contracts the life and pension insurance industry should offer.

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How Much Would You Pay to Resolve Long-Run Risk?

The American Economic Review ◽

10.1257/aer.104.9.2680 ◽

2014 ◽

Vol 104 (9) ◽

pp. 2680-2697 ◽

Cited By ~ 86

Author(s):

Larry G. Epstein ◽

Emmanuel Farhi ◽

Tomasz Strzalecki

Keyword(s):

Asset Pricing ◽

Temporal Resolution ◽

Recursive Utility ◽

Elasticity Of Intertemporal Substitution ◽

Careful Scrutiny ◽

Long Run ◽

Quantitative Properties ◽

Long Run Risks ◽

Asset Pricing Puzzles ◽

Long Run Risk

Though risk aversion and the elasticity of intertemporal substitution have been the subjects of careful scrutiny, the long-run risks literature as well as the broader literature using recursive utility to address asset pricing puzzles has ignored the full implications of their parameter specifications. Recursive utility implies that the temporal resolution of risk matters and a quantitative assessment thereof should be part of the calibration process. This paper gives a sense of the magnitudes of implied timing premia. Its objective is to inject temporal resolution of risk into the discussion of the quantitative properties of long-run risks and related models. (JEL D81, G11, G12)

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