Recursive Preferences, Correlation Aversion, and the Temporal Resolution of Uncertainty

Lorenzo Maria Stanca

Papers from arXiv.org

Abstract: This paper investigates a novel behavioral feature of recursive preferences: aversion to risks that persist over time, or simply correlation aversion. Greater persistence provides information about future consumption but reduces opportunities to hedge consumption risk. I show that, for recursive preferences, correlation aversion is equivalent to increasing relative risk aversion. To quantify correlation aversion, I develop the concept of the persistence premium, which measures how much an individual is willing to pay to eliminate persistence in consumption. I provide an approximation of the persistence premium in the spirit of Arrow-Pratt, which provides a quantitative representation of the trade-off between information and hedging. I present several applications. The persistence premium helps create more realistic calibrations for macro-finance models. In an optimal taxation model, I show that recursive preferences unlike standard preferences-lead to more progressive taxation when human capital persistence is greater. Finally, I show that correlation-averse preferences have a variational representation, linking correlation aversion to concerns about model misspecification.

Date: 2023-04, Revised 2025-01
New Economics Papers: this item is included in nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://arxiv.org/pdf/2304.04599 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2304.04599

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().