AbstractA major virtue of von Neumann-Morgenstern utilities, for example, in the theory of general financial equilibrium (GFE), is that they ensure time consistency: consumption-portfolio plans (for the future) are in fact executed (in the future) — assuming that there is perfect foresight about relevant endogenous variables. This paper proposes an alternative to expected utility, one which also delivers consistency between plan and execution — and more. In particular, the formulation affords an extremely natural setting for introducing extrinsic uncertainty. The key idea is to divorce the concept of filtration (of the state space) from any considerations involving probability, and then concentrate attention on nested utilities of consumption looking forward from any date-event: utility today depends only on consumption today and prospective utility of consumption tomorrow, utility tomorrow depends only on consumption tomorrow and prospective utility of consumption the day after tomorrow, and so on.
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Bibliographic InfoPaper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 07-036.
Length: 9 pages
Date of creation: 15 Dec 2007
Date of revision:
Utility theory; Expected utility; Time consistency; Extrinsic uncertainty; Cass-Shell Immunity Theorem;
Other versions of this item:
- D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-01-05 (All new papers)
- NEP-CBA-2008-01-05 (Central Banking)
- NEP-HPE-2008-01-05 (History & Philosophy of Economics)
- NEP-UPT-2008-01-05 (Utility Models & Prospect Theory)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Johnsen, Thore H & Donaldson, John B, 1985. "The Structure of Intertemporal Preferences under Uncertainty and Time Consistent Plans," Econometrica, Econometric Society, vol. 53(6), pages 1451-58, November.
- Balasko, Yves, 1983. "Extrinsic uncertainty revisited," Journal of Economic Theory, Elsevier, vol. 31(2), pages 203-210, December.
- Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
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