Survival and long-run dynamics with heterogeneous beliefs under recursive preferences

Abstract

I study the long-run behavior of an economy with two types of agents who differ in their beliefs and are endowed with homothetic recursive preferences of the Duffie- Epstein-Zin type. Contrary to models with separable preferences in which the wealth of agents with incorrect beliefs vanishes in the long run, recursive preference specifications also lead to equilibria where both agents survive, or more incorrect agents dominate. In this respect, the market selection hypothesis is not robust to deviations from separability. I derive analytical conditions for the existence of nondegenerate long-run equilibria in which agents with differently accurate beliefs coexist in the long run, and show that these equilibria exist for broad ranges of plausible parameterizations when risk aversion is larger than the inverse of the intertemporal elasticity of substitution. These results provide a justification for models that combine belief heterogeneity and recursive preferences.