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Is time consistency compatible with risk aversion?

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  • Günter Bamberg
  • Michael Krapp

Abstract

Managerial decision models applied in operations research, finance, information management, and many other disciplines are typically both dynamic and stochastic. When decisions at different points in time are allowed, the question arises what conditions guarantee the absence of incentives to deviate from the ex ante optimal policy at later dates. We term such a policy time consistent. A well-known result states that additively separable objective functions ensure time consistency under risk neutrality. Unfortunately, this is no longer true when decision makers are risk averse. Then, (much) more restrictive assumptions are needed. The aim of this paper is to provide clear-cut conditions that ensure time consistency in an expected utility framework. Our main findings are twofold: on the one hand, constant absolute risk aversion can guarantee time consistency when final values are under consideration. On the other hand, time consistency and risk aversion are incompatible when intertemporal payments are aggregated by means of net present values. Copyright Springer-Verlag Berlin Heidelberg 2016

Suggested Citation

  • Günter Bamberg & Michael Krapp, 2016. "Is time consistency compatible with risk aversion?," Review of Managerial Science, Springer, vol. 10(2), pages 195-211, March.
    • Handle: RePEc:spr:rvmgts:v:10:y:2016:i:2:p:195-211
    DOI: 10.1007/s11846-014-0142-8
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    Cited by:

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    2. Schur, Rouven & Gönsch, Jochen & Hassler, Michael, 2019. "Time-consistent, risk-averse dynamic pricing," European Journal of Operational Research, Elsevier, vol. 277(2), pages 587-603.
    3. Walter Krämer, 2018. "Interview mit Günter Bamberg," AStA Wirtschafts- und Sozialstatistisches Archiv, Springer;Deutsche Statistische Gesellschaft - German Statistical Society, vol. 12(3), pages 299-307, December.

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    More about this item

    Keywords

    Discounting; Dynamic planning; Impossibility theorems; Time consistency; Risk aversion; D81; D90;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General

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