A 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.
|Date of creation:||15 Dec 2007|
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- Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
- 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.
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