Information Processing with Recursive Utility: Some Intriguing Results

Abstract

Much of the recent research in Macroeconomics and Finance uses models where the representative agent has a recursive utility function. We study information processing with such preferences in a simple endowment economy where consumption growth rates are autocorrelated. We show that for typical parameter values, positively correlated consumption growth rates introduce a strong incentive for ignoring information on the current state of the economy. We esti- mate the model on postwar US data and find that the representative consumer can achieve a utility gain equivalent to a 20 % increase in lifetime consumption simply by not paying attention to the state of the economy.