Dynamic Programming with Recursive Preferences: Optimality and Applications

Abstract: This paper provides new conditions for dynamic optimality in discrete time and uses them to establish fundamental dynamic programming results for several commonly used recursive preference specifications. These include Epstein-Zin preferences, risk-sensitive preferences, narrow framing models and recursive preferences with sensitivity to ambiguity. The results obtained for these applications include (i) existence of optimal policies, (ii) uniqueness of solutions to the Bellman equation, (iii) a complete characterization of optimal policies via Bellman's principle of optimality, and (iv) a globally convergent method of computation via value function iteration.