Recursive utility and jump-diffusions

Knut Aase

No 2025/6, Discussion Papers from Norwegian School of Economics, Department of Business and Management Science

Abstract: We consider agents in an exchange economy having preferences represented by scale invariant recursive utility, where the dynamics of both consumption and risky assets are given by jump-diffusions. In this setting we find state prices, where both diffusion and jump-size risk are priced. By including jumps, the theory has the potential to model insurance markets, as well as ordinary securities’ markets. In the latter case, we derive the equilibrium, real interest rate and risk premiums. In the former case we consider catastrophe futures related to negative shocks in consumption. We use the stochastic maximum principle to analyze the model. This method uses forward/backward stochastic differential equations, and seems indispensable in this theory.

Keywords: Recursive utility; jump dynamics; the stochastic maximum principle; jump size risk; catastrophe futures (search for similar items in EconPapers)
JEL-codes: D51 D53 D90 E21 G10 G12 (search for similar items in EconPapers)
Pages: 63 pages
Date: 2025-02-24
New Economics Papers: this item is included in nep-upt
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https://hdl.handle.net/11250/3180099 Full text (application/pdf)

Related works:
Working Paper: Recursive utility and jump-diffusions (2015)
Working Paper: Recursive utility and jump-diffusions (2014)
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