Pessimistic optimal choice for risk-averse agents

Paolo Vitale

No 1306, Working Papers CASMEF from Dipartimento di Economia e Finanza, LUISS Guido Carli

Abstract: We propose a general framework for the analysis of dynamic optimization with risk- averse agents, extending WhittleÕs (Whittle, 1990) formulation of risk-sensitive optimal control problems to accommodate time-discounting. We show how, within a Markovian set-up, optimal risk-averse behavior is identified via a pessimistic choice mechanism and described by simple recursive formulae. We apply this methodology to two distinct problems formulated respectively in discrete- and continuous-time. In the former, we extend SvennsonÕs (Svennson, 1997) analysis of optimal monetary policy, showing that with a risk-averse central bank the inflation forecast is not longer an explicit intermediate target, the monetary authorities do not expect the inflation rate to mean revert to its target level and apply a more aggressive Taylor rule than under risk-neutrality, while the inflation rate is less volatile. In the latter, we investigate the optimal production policy of a monopolist which faces a demand schedule subject to stochastic shocks, once again showing that risk-aversion induces her to act more aggressively.

Keywords: Pessimistic Agents; Time-discounting; Linear Exponential Quadratic Gaussian. (search for similar items in EconPapers)
JEL-codes: C61 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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