Abstract
We extend Hansen and Sargent's (Discounted linear exponential quadratic gaussian control, 1994, IEEE Trans Autom Control 40:968---971 1995, 2013) analysis of dynamic optimization with risk-averse agents in two directions. Firstly, following Whittle (Risk-sensitive optimal control, 1990), we show that the optimal risk-averse policy is identified via a pessimistic choice mechanism and described by simple recursive formulae. Secondly, we investigate the continuous-time limit and show that sufficient conditions for the existence of optimal solutions coincide with those which apply under risk-neutrality. Our analysis is conducted both under perfect and imperfect state observation. As an illustrative example, we analyze the optimal production policy of an entrepreneur running a monopolistic firm which faces a demand schedule subject to stochastic shocks, showing that risk-aversion induces her to act more aggressively.
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