Recursive Utility, Endogenous Growth, and the Welfare Cost of Volatility
IMF Working Papers, January 1, 2001
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- Recursive Utility, Endogenous Growth, and the Welfare Cost of Volatility
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Bibliographic details
- Authors: Aude Pommeret, Anne Epaulard
- Published: January 1, 2001
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451842180.001
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.
- The measure 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.
Core findings and analytical contributions
- Introduces a welfare-cost measure within an AK endogenous growth framework under uncertainty, extended to recursive utility that separates risk aversion from intertemporal elasticity of substitution.
- Identifies two components of welfare cost:
- direct cost from fluctuations, and
- cost arising because consumption is endogenous to the growth process.
- Demonstrates that the total welfare cost of volatility is increasing in:
- risk aversion, and
- intertemporal elasticity of substitution.
- Notes that when agent preference parameters take plausible values, the welfare cost of volatility can exceed welfare-cost measures derived assuming consumption follows an exogenous process.
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- Recursive Utility, Endogenous Growth, and the Welfare Cost of Volatility - WP/01/5