Scale-invariant asset pricing and consumption/portfolio choice with general attitudes toward risk and uncertainty

Motivated by notions of aversion to Knightian uncertainty, this paper develops the theory of competitive asset pricing and consumption/portfolio choice with homothetic recursive preferences that allow essentially any homothetic uncertainty averse certainty-equivalent form. The market structure is scale invariant but otherwise general, allowing any trading constraints that scale with wealth. Technicalities are minimized by assuming a finite information tree. Pricing restrictions in terms of consumption growth and market returns are derived and a simple recursive method for solving the corresponding optimal consumption/portfolio choice problem is established. ∗Kellogg School of Management, Department of Finance, Northwestern University, 2001 Sheridan Road, Evanston, IL 60208. This working paper replaces an earlier version titled "Scale-Invariant Asset Pricing Theory: A General Discrete Framework with Ambiguity-Aversion Applications." I thank Snehal Banerjee, Soohun Kim, Peter Klibanoff, Ioan Mirciov, Dimitri Papanikolaou, Jonathan Parker, Mark Schroder and Viktor Todorov for helpful discussions or feedback. I am responsible for any errors.