Dynamic Preference for Flexibility

R. Vijay Krishna and Philipp Sadowski

No 10-68, Working Papers from Duke University, Department of Economics

Abstract: Following Kreps (1979), we consider a decision maker who is uncertain about her future taste for immediate consumption. This uncertainty leaves the decision maker with a preference for flexibility: When choosing among menus containing alternatives for future choice, she weakly prefers menus with additional alternatives. Existing representations accommodating this choice pattern cannot address dynamic decision situations like a consumption savings problem. We provide representations of choice over continuation problems that are recursive and take the form of Bellman equations. Two specific models are axiomatized. They feature stationary and Markovian beliefs over future tastes, respectively. The parameters of the representations, which are relative intensities of tastes, beliefs over those tastes and the discount factor, are uniquely identified from behavior. We characterize a natural notion of ’greater preference for flexibility’ in terms of a stochastic order on beliefs and give an example of a Lucas tree economy, where a representative agent with greater preference for flexibility corresponds to larger price volatility in the sense of second order stochastic dominance.

Pages: 45
Date: 2010
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