Recursive Utility, Endogenous Growth, and the Welfare Cost of Volatility

January 1, 2001

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper proposes a measure of the welfare cost of volatitliy derived from an endogenous growth model (AK) under uncertainty extended to the case of a recursive utility function which disentangles risk aversion from intertemporal elasticity of substitution. It encompasses a direct welfare cost of fluctuations and a welfare cost due to the endogeneity of the consumption. The total welfare cost of volatility increases with both the risk aversion and the intertemporal elasticity of substitution. For plausible values of the agent's preference parameters, the cost of volatility may be greater than measures bases on an exogenous process for consumption.

Subject: Business cycles, Capital accumulation, Consumption, Economic growth, Financial institutions, National accounts, Return on investment, Stocks

Keywords: Business cycles, Capital accumulation, Consumption, consumption process, consumption-saving trade-off, cost of volatility, Endogenous Growth, growth rate, Recursive Utility, Return on investment, Risk, saving-consumption trade-off matter, Stocks, utility function, welfare cost, Welfare Cost of Fluctuations, WP

Pages:
23
Volume:
2001
DOI:
https://doi.org/10.5089/9781451842180.001
Issue:
005
Series:
Working Paper No. 2001/005
Stock No:
WPIEA0052001
ISBN:
9781451842180
ISSN:
1018-5941

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