Recursive Utility and Structural Uncertainty (joint with Nabil Al-Najjar)

Elath Hall, 2nd floor, Feldman Building, Edmond J. Safra Campus
Sunday, December 18, 2016 - 16:00
Eran Shmaya
Northwestern University

We consider a decision maker with recursive utility, as formalized by Epstein and Zin (1989). We show that, as this decision maker  becomes more patient, his ranking of conditionally i.i.d. processes is approximately that of an expected utility decision maker. The utility function we derive has a simple closed form that makes explicit the connection between the parameters of the Epstein-Zin utility and the distinction between risk (variability of outcomes with known probability)  and structural uncertainty about the process.  Our results also imply that such a decision maker is indifferent to the timing of resolution of uncertainty, yet may display different attitudes towards risk and inter-temporal substitution.