Optimally eating a stochastic cake: a recursive utility approach

Abstract

In this short paper, uncertainties on resource stock and on technical progress are introduced into an intertemporal equilibrium model of optimal extraction of a non-renewable resource. The representative consumer maximizes a recursive utility function which disentangles between intertemporal elasticity of substitution and risk aversion. A closed-form solution is derived for both the optimal extraction and price paths. The value of the intertemporal elasticity of substitution relative to unity is then crucial in understanding extraction. Moreover, this model leads to a non-renewable resource price following a geometric Brownian motion.