LINKED RECURSIVE PREFERENCES AND OPTIMALITY. (9th October 2013)

• Record Type: Journal Article
• Authors: Levental, Shlomo; Sinha, Sumit; Schroder, Mark
• Is Part Of: Mathematical finance. Volume 26:Number 1(2016:Jan.)
• Page Start: 86
• Page End: 121
• Publication Date: 2013-10-09
• Subjects: BSDE -- recursive preferences -- translation‐invariant preferences -- team contract -- Pareto optimality -- behavioral contract theory -- optimization; Business mathematics -- Periodicals; 332
• DOI: 10.1111/mafi.12047
• Languages: English
• ISSNs: 0960-1627

Abstract

Abstract : We study a class of optimization problems involving linked recursive preferences in a continuous‐time Brownian setting. Such links can arise when preferences depend directly on the level or volatility of wealth, in principal–agent (optimal compensation) problems with moral hazard, and when the impact of social influences on preferences is modeled via utility (and utility diffusion) externalities. We characterize the necessary first‐order conditions, which are also sufficient under additional conditions ensuring concavity. We also examine applications to optimal consumption and portfolio choice, and applications to Pareto optimal allocations.