Restricted dynamic consistency

Lorenzo Stanca ()
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Lorenzo Stanca: Collegio Carlo Alberto and University of Turin

Economic Theory, 2025, vol. 80, issue 4, No 7, 1203-1231

Abstract: Abstract Dynamic consistency is a key behavioral property in dynamic economic models, making it possible to use tractable dynamic programming techniques. However, when combined with the separation of time and risk preferences, it can lead to unrealistic predictions that contradict empirical evidence. This paper demonstrates that dynamic consistency can be relaxed to hold over a much smaller domain of consumption programs while maintaining sufficient richness for practical applications and allowing the separation of risk aversion from intertemporal substitution. As an application, I introduce a new model of dynamic preferences, the Epstein–Zin–Selden–Stux preferences. These preferences are recursive only within a restricted domain. Recent experimental results by Meissner and Pfeiffer (J Econ Theory 200:105379, 2022), which Epstein–Zin preferences cannot rationalize, find a natural explanation through this new model. Finally, I consider an application of this new model to a consumption-investment problem.

Keywords: Recursive utility; Dynamic consistency; Intertemporal substitution; Risk aversion (search for similar items in EconPapers)
JEL-codes: C61 D81 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s00199-025-01655-3

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