Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2014/9: Recursive utility and jump-diffusions

Knut K. Aase ()
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Knut K. Aase: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: We derive the equilibrium interest rate and risk premiums using recursive utility for jump-diffusions. Compared to to the continuous version, including jumps allows for a separate risk aversion related to jump size risk in addition to risk aversion related to the continuous part. We also consider a version that allows marginal utility to depend on past consumption. The models with jumps are shown to have a potential to give better explanation of empirical regularities than the recursive models based on merely continuous dynamics.

Keywords: Recursive utility; jump dynamics; the stochastic maximum principle; early resolution; utility gradients

JEL-codes: D51; D53; D90; E21; G10; G12

41 pages, March 25, 2014

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