Long-run Consumption Risk and Asset Allocation under Recursive Utility and Rational Inattention

Yulei Luo () and Eric Young

MPRA Paper from University Library of Munich, Germany

Abstract: We study the portfolio decision of a household with limited information-processing capacity (rational inattention or RI) in a setting with recursive utility. We find that rational inattention combined with a preference for early resolution of uncertainty could lead to a significant drop in the share of portfolios held in risky assets, even when the departure from standard expected utility with rational expectations is small. In addition, we show that the equilibrium equity premium increases with the degree of inattention because inattentive investors with recursive utility face greater long-run risk and thus require higher compensation in equilibrium. Our results are robust to the presence of correlation between the equity return and the RI-induced noise and the presence of non-tradable labor income.

Keywords: Rational Inattention; Recursive Utility; Portfolio Choice; Asset Pricing (search for similar items in EconPapers)
JEL-codes: D53 D81 G11 (search for similar items in EconPapers)
Date: 2013-07-08
New Economics Papers: this item is included in nep-dge and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/52904/1/MPRA_paper_52904.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/57112/1/MPRA_paper_52904.pdf revised version (application/pdf)

Related works:
Journal Article: Long‐Run Consumption Risk and Asset Allocation under Recursive Utility and Rational Inattention (2016)
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:pra:mprapa:52904

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().