Smooth Ambiguity Aversion Toward Small Risks and Continuous-Time Recursive Utility
Assuming Brownian/Poisson uncertainty, a certainty equivalent (CE) based on the smooth second-order expected utility of Klibanoff, Marinacci, and Mukerji (Econometrica, 2005) is shown to be approximately equal to an expected-utility CE. As a consequence, the corresponding continuous-time recursive utility form is the same as for Kreps-Porteus utility. The analogous conclusions are drawn for a smooth divergence CE, based on a formulation of Maccheroni, Marinacci, and Rustichini (Econometrica, 2006), but only under Brownian uncertainty. Under Poisson uncertainty, a smooth divergence CE can be approximated with an expected-utility CE if and only if it is of the entropic type. A non-entropic divergence CE results in a new class of continuous-time recursive utilities that price Brownian and Poissonian risks differently.
Skiadas, Constantinos. 2013. Smooth Ambiguity Aversion Toward Small Risks and Continuous-Time Recursive Utility. Journal of Political Economy. 121: 775792.