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Incomplete market demand tests for Kreps-Porteus-Selden preferences

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  • Kubler, Felix
  • Selden, Larry
  • Wei, Xiao

Abstract

What does utility maximization subject to a budget constraint imply for intertemporal choice under uncertainty? Assuming consumers face a two period consumption-portfolio problem where asset markets are incomplete, we address this question following both the standard local infinitesimal and finite data approaches. To focus on the separate roles of time and risk preferences, individuals maximize KPS (Kreps-Porteus-Selden) preferences. The consumption-portfolio problem is decomposed into a one period portfolio problem and a two period certainty consumption-saving problem. We derive demand restrictions which are necessary and sufficient, for portfolio choices and certainty intertemporal consumption to have been generated by maximization, respectively, of a one period expected utility representation and a certainty representation of time preferences. Conditions are provided for recovering the building block time and risk preference utilities. For the finite data case, we derive a set of linear inequalities that are necessary and sufficient for observations to be consistent with the maximization of KPS utility.

Suggested Citation

  • Kubler, Felix & Selden, Larry & Wei, Xiao, 2020. "Incomplete market demand tests for Kreps-Porteus-Selden preferences," Journal of Economic Theory, Elsevier, vol. 185(C).
    • Handle: RePEc:eee:jetheo:v:185:y:2020:i:c:s002205311930122x
    DOI: 10.1016/j.jet.2019.104973
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    References listed on IDEAS

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    More about this item

    Keywords

    Kreps-Porteus-Selden preferences; Expected utility; Contingent claims; Integrability; Incomplete markets;
    All these keywords.

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General

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