Consumption Paths under Prospect Utility in an Optimal Growth Model

This paper studies the Cass-Koopmans-Ramsey model of optimal economic growth with a representative agent whose preferences for consumption can be gradually varied between the standard CES case and Kahneman and Tversky's prospect utility. The numerical analysis of a specific parametrization shows that the transitional dynamics of optimal consumption paths differs distinctly from the standard model if benchmark levels and loss aversion matter in the agent's instantaneous utility. When interpreting this dynamics in the standard model with additively separable preferences, one would mistakenly conclude the existence of a negative technology shock...