Safety in Markets: An Impossibility Theorem for Dutch Books

Leeat Yariv and David Laibson ()

No 867, 2004 Meeting Papers from Society for Economic Dynamics

Abstract: This paper explores the extent to which markets constrain intertemporal preferences. First, we show that without transaction costs, agents are immune to exploitation in competitive markets. In particular, a sequence of trades leaving any market participant strictly worse off (termed a money losing Dutch book) is generically impossible. When transaction costs exist in the market, Dutch books are plausible only when agents have inaccurate beliefs about their own future behavior. Thus, markets are appropriate filters of non-standard (time-inconsistent) preferences only when sufficient irrational behavioral expectations are allowed. Second, we show that while non-standard preferences may be sustained in competitive markets, they are generically non-identifiable. Under mild conditions, any profile of demands can be explained with a standard, time-consistent, model. Nonetheless, we demonstrate that such a model will have weak predictive power across markets if non-standard preferences indeed prevail.

Keywords: Dutch books; money pumps; time inconsistency; markets (search for similar items in EconPapers)
JEL-codes: D50 D90 (search for similar items in EconPapers)
Date: 2004
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Related works:
Working Paper: Safety in Markets: An Impossibility Theorem for Dutch Books (2007)
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Persistent link: http://EconPapers.repec.org/RePEc:red:sed004:867

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