Uncertain Decisions pp 83-107 | Cite as

# Consumption, Savings and Asset Returns with Non-Expected Utility

## Abstract

Over the last dozen years, the standard models of decision making under risk and uncertainty have come under renewed scrutiny because of their failure to describe choices observed in experimental settings; the Allais and Ellsberg paradoxes are the best known instances of descriptive failures of the (subjective) expected utility model. In addition, a number of generalizations of the expected utility model have been developed. These ‘nonexpected utility’ theories have proven useful in several ways. First, they have provided models of preference that can ‘explain’, or at least accommodate the cited experimental evidence. Equally important, they have stimulated new experimental tests of decision making in laboratory settings that should help to provide further insights into the way in which subjects make choices. In addition, they have provided a deeper understanding of the expected utility model, both at an axiomatic level and at the more practical level of clarifying why it is that the expected utility model has proven so tractable in modeling applications.

## Keywords

Risk Aversion Euler Equation Asset Price Asset Return Certainty Equivalent## Preview

Unable to display preview. Download preview PDF.

## References

- Bonomo, M. and R. Garcia (1993), “Disappointment Aversion as a Solution to the Risk-Free Puzzle”, U. Montreal, mimeo.Google Scholar
- Campbell, J.Y. (1994), “Intertemporal Asset Pricing without Consumption Data”,
*American Economic Review***83**, 487–512.Google Scholar - Campbell, J.Y. and J.H. Cochrane (1994), “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behaviour,” NBER #4995.Google Scholar
- Chami, R., T. Cosimano and C. Fullenkamp (1994), “A General Equilibrium Approach to Asset Pricing in an Efficient Market,” Working Paper, U. Notre Dame,.Google Scholar
- Chew, S.H. (1989), “Axiomatic Utility Theories with the Betweeness Property”,
*Annals of Operations Research***19**, 273–298.CrossRefGoogle Scholar - Chew, S.H. and L.G. Epstein (1991), “Recursive Utility Under Uncertainty,” in
*Equilibrium Theory with an Infinite Number of Commodities*, A. Khan and N. Yannelis eds., New York: Springer, 352–369.Google Scholar - Cochrane, J.H. and L.P. Hansen (1992), “Asset Pricing Explorations for Macroeconomics”, NBER Working Paper #4088.Google Scholar
- Constantinides, G.M. (1990), “Habit Formation: A Resolltion of the Equity Premium Puzzle”,
*J Pol. Econ.***98**, 519–543.CrossRefGoogle Scholar - Dekel, E. (1986), “An Axiomatic Characterization of Preferences Under Uncertainty”,
*J. Econ. Theory***40**, 304–318.CrossRefGoogle Scholar - Duffie, D. and L.G. Epstein (1992a), “Stochastic Differential Utility,”
*Econometrica***60**, 353–394.CrossRefGoogle Scholar - Duffie, D. and L.G. Epstein (1992b), “Asset Pricing with Stochastic Differential Utility,”
*R. Fin. Stud.***5**, 411–436.CrossRefGoogle Scholar - Epstein, L.G. (1988), “Risk Aversion and Asset Prices”,
*J. Monetary Ecs.***22**,179–192.CrossRefGoogle Scholar - Epstein, L.G. (1992), “Behaviour Under Risk: Recent Developments in Theory and Applications”, in
*Advances in Economic Theory*, Vol.II. J.J. Laffont ed., Cambridge U. Press.Google Scholar - Epstein, L.G. and M. LeBreton (1993), “Dynamically Consistent Beliefs Must Be Bayesian,”
*J. Ec. Theory***61**, 1–22.CrossRefGoogle Scholar - Epstein, L.G. and A. Melino (1995), “A Revealed Preference Analysis of Asset Pricing Under Recursive Utility,”
*Rev. Ec. Stud.***62**, 597–618.CrossRefGoogle Scholar - Epstein, L.G. and T. Wang (1994), “Intertemporal Asset Pricing Under Knightian Uncertainty”,
*Econometrica***62**, 283–322.CrossRefGoogle Scholar - Epstein, L.G. and T. Wang (1995), “Uncertainty, Risk-Neutral Measures and Security Price Booms and Crashes,”
*J. Ec. Theory***67**, 40–82.CrossRefGoogle Scholar - Epstein, L.G. and S. Zin (1989), “Substitution, Risk Aversion and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework”,
*Econometrica*,**57**, 937–969.CrossRefGoogle Scholar - Epstein, L.G. and S. Zin (1990), “First-Order Risk Aversion and the Equity Premium Puzzle”,
*J. Monetary Ecs.***26**, 387–407.CrossRefGoogle Scholar - Epstein, L.G. and S. Zin (1991), “Substitution, Risk Aversion and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis”,
*J. Pol. Econ.***99**, 263–286.CrossRefGoogle Scholar - Epstein, L.G. and S. Zin (1992), “The Independence Axiom and Asset Returns”, NBER Technical Working Paper #109.Google Scholar
- Gilboa, I. and D. Schmeidler (1989), “Maxmin Expected Utility with Nonunique Prior,”
*J. Math. Econ.***18**, 141–153.CrossRefGoogle Scholar - Gordon, S., L. Samson and B. Carmichael (1994), “Sampling-Based Estimation of the Intertemporal Marginal Rate of Substitution”, Cahier 9401, U. Laval.Google Scholar
- Grossman, S.J. and R.J. Shiller (1981), “The Determinants of the Variability of Stock Market Prices”,
*American Economic Review***71**, 222–227.Google Scholar - Gul, F. (1991), “A Theory of Disappointment Aversion,”
*Econometrica***59**, 667–686.CrossRefGoogle Scholar - Hadar, J. and W.R. Russell (1969), “Rules for Ordering Uncertain Prospects”,
*American Economic Review***59**, 25–34.Google Scholar - Hansen, L.P. and S. Richard (1987), “The Role of Conditioning Information in Deducing Testable Restrictions Implied by Dynamic Asset Pricing Models,”
*Econometrica***55**, 587–614.CrossRefGoogle Scholar - Hansen, L.P. and T.J. Sargent (1992), “Discounted Linear Exponential Quadratic Gaussian Control”, mimeo.Google Scholar
- Hansen, L.P., T.J. Sargent and T.D. Tallarini Jr. (1993), “Pessimism, Neurosis, and Feelings about Risk in General Equilibrium”, mimeo.Google Scholar
- Hansen, L.P. and K.J. Singleton (1983), “Stochastic Consumption, Risk Aversion and the Temporal Behavior of Asset Returns”,
*J. Pol. Econ.***91**, 249–265.CrossRefGoogle Scholar - Hung, M.W. (1994), “The Interaction Between Nonexpected Utility and Assymmetric Market Fundamentals,”
*J. Finance***49**, 325–343.CrossRefGoogle Scholar - Kandel, S. and R.F. Stambaugh (1991), “Asset Returns and Intertemporal Preferences”,
*J. Monetary Ecs.***27**, 39–71.CrossRefGoogle Scholar - Keynes, J. M. (1936),
*The General Theory of Employment Interest and Money*.London: Macmillan.Google Scholar - Klibanoff, P. (1993), “Dynamic Choice with Uncertainty Aversion,” Kellogg School, Northwestern U., mimeo.Google Scholar
- Kocherlakota, N. (1987),
*State Nonseparability: Theory and Empirical Implications*, Ph.D. Thesis, U. Chicago.Google Scholar - Kreps, D. and E. L. Porteus (1978), “Temporal Resolution of Uncertainty and Dynamic Choice Theory,”
*Econometrica***46**, 185–200.CrossRefGoogle Scholar - Lucas, R.E. Jr. (1978), “Asset Prices in an Exchange Economy”,
*Econometrica*,**46**, 1429–1445.CrossRefGoogle Scholar - Ma, C. (1993), “Market Equilibrium with Heterogeneous Agents and Recursive-Utility-Maximizing Agents,”
*Economic Theory***3**, 243–266.CrossRefGoogle Scholar - Machina, M.J. (1982), ‘“Expected Utility’ Analysis Without the Independence Axiom,”
*Econometrica***50**, 1069–1079.CrossRefGoogle Scholar - Machina, M.J. (1989), “Dynamic Consistency and Non-Expected Utility Models of Choice Under Uncertainty,”
*J. Ec. Lit.***27**, 1622–1668.Google Scholar - Machina M.J. and D. Schmeidler (1992), “A More Robust Definition of Subjective Probability,”
*Econometrica***60**, 745–780.CrossRefGoogle Scholar - Mehra, R. and E. Prescott (1985), “The Equity Premium: A Puzzle”,
*J. Monetary Ecs.***15**, 145–161.CrossRefGoogle Scholar - Melino, A. and L.G. Epstein (1995), “An Empirical Analysis of Asset Returns Under ‘Non-Bayesian Rational Expectations’,” mimeo.Google Scholar
- Naik, V. (1994), “Asset Prices in Dynamic Production Economies with TimeVarying Risk,”
*Rev. Fin. Stud.***7**, 781–801.CrossRefGoogle Scholar - Obstfeld, M. (1992), “Evaluating Risky Consumption Paths: The Role of Intertemporal Substitutability”, NBER Technical Working Paper #120.Google Scholar
- Ozaki, H. and P. Streufert (1996), “Dynamic Programming for Non-Additive Stochastic Objectives,”
*Journal of Mathematical Economics*,**25**(4),391–442.CrossRefGoogle Scholar - van der Ploeg, F. (1993), “A Closed-Form Solution for a Model of Precautionary Saving,”
*Rev. Econ. Studies***60**, 385–396.CrossRefGoogle Scholar - Restoy, F. and P. Weil (1994), “Approximate Equilibrium Asset Prices,” mimeo.Google Scholar
- Schmeidler, D. (1989), “Subjective Probability and Expected Utility Without Additivity,”
*Econometrica***57**, 571–587.CrossRefGoogle Scholar - Skiadas, C. (1995), “Time Coherent Choice and Preferences for Information,” Working Paper #196, Kellogg School, Northwestern University.Google Scholar
- Walley, P. (1991),
*Statistical Reasoning with Imprecise Probabilities*, Chapman and Hall, London.Google Scholar - Wang, S. (1993), “The Local Recoverability of Risk Aversion and Intertemporal Substitution”,
*J. Econ. Theory***59**, 333–363.CrossRefGoogle Scholar - Weil, P. (1989), “The Equity Premium Puzzle and the Risk-Free Rate Puzzle”,
*J. Monetary Ecs.***24**, 401–422.CrossRefGoogle Scholar - Weil, P. (1990), “Nonexpected Utility in Macroeconomics”,
*Quarterly J. Ecs.***105**, 29–42.CrossRefGoogle Scholar - Weil, P. (1993), “Precautionary Savings and the Permanent Income Hypothesis,”
*Rev. Econ. Studies***60**, 367–384.CrossRefGoogle Scholar