LINKED RECURSIVE PREFERENCES AND OPTIMALITY

We study a class of optimization problems involving linked recursive preferences in a continuous‐time Brownian setting. Such links can arise when preferences depend directly on the level or volatility of wealth, in principal–agent (optimal compensation) problems with moral hazard, and when the impact of social influences on preferences is modeled via utility (and utility diffusion) externalities. We characterize the necessary first‐order conditions, which are also sufficient under additional conditions ensuring concavity. We also examine applications to optimal consumption and portfolio choice, and applications to Pareto optimal allocations.