Stochastic dynamic programming under recursive Epstein-Zin preferences

Abstract: This paper investigates discrete-time Markov decision processes with recursive utilities (or payoffs) defined by the classic CES aggregator and the Kreps-Porteus certainty equivalent operator. According to the classification introduced by Marinacci and Montrucchio, the aggregators that we consider are Thompson. We focus on the existence and uniqueness of a solution to the Bellman equation. Since the per-period utilities can be unbounded, we work with the weighted supremum norm. Our paper shows three major points for such models. Firstly, we prove that the Bellman equation can be obtained by the Banach fixed point theorem for contraction mappings acting on a standard complete metric space. Secondly, we need not assume any boundary conditions, which are present when the Thompson metric or the Du's theorem are used. Thirdly, our results give better bounds for the geometric convergence of the value iteration algorithm than those obtained by Du's fixed point theorem. Moreover, our techniques allow to derive the Bellman equation for some values of parameters in the CES aggregator and the Kreps-Porteus certainty equivalent that cannot be solved by Du's theorem for increasing and convex or concave operators acting on an ordered Banach space.